Yes, accountants normally hold a position of unquestionable authority when it comes to the financials of your business…

- “Why did you do that?”

- “I dunno, my accountant told me to!”

However, few small business owners are aware that the decisions their accountant make (for the presentation of numbers on paper) can significantly impede the growth and success of their business!

Accountants assume that you, as manager of your own business, understand your own working capital needs and have prepared for them accordingly.  Most accountants today are trained to chase tax savings  to the farthest extent – they are on a tax jihad.  Maneuvering the tax code to save you $$ is their holy war.

That is a good thing if you are making millions and need some creative solutions to shovel some of the profit off to get you down to the limit for the Canadian Small Business tax deduction (limit is $500K as of 2011).  However, there is something to be said of expensing your dog food, your daughters boyfriends car, and the flight to see Aunt Gladys.

Your numbers on paper – financial statements- show the government (for tax), bankers (for loans to support your growth), investors (to support your growth), and future buyers (to fund your retirement to a place with palm trees and cocktails) – just how successful/profitable your business is.

If your accountant is only catering to one audience (the government), you will be sure to pay little or no taxes, but you will be out of the game all together with it comes to getting a loan, attracting investors or having a hope of selling your company.

BABY BOOMERS – Pay Attention!

A staggering majority of all small businesses are owned by baby boomers and will change ownership in the next 5 years.  There are not enough generation X,Y or Z ready or willing to buy that many businesses.  Only those that are wrapped up with a nice transition plan, proper accounting practices, documented procedures (think ISO certification) and a healthy profit showing for the last 3 years will get a motivated buyer.

Also, even if you find someone interested in buying your business, unless they are cash rich, they will need to get a loan to buy it from you.  In that case, your statements better impress the bank!

Even if you show a profit of $500K (just under the small business deduction limit), that is lots of cash-flow to debt service all sorts of debt. That is a healthy profit to attract many investors, and it is certainly enticing to a potential buyer to take over.

Think of it this way…. Your company must show about $30K of net profit to make a bank comfortable with lending you $100K.  That is just one of the factors, but keep that in mind when tax planning.  You need to leave at least that much meat on the bones to show the business can handle the new burden it is taking on.

If you normally don’t need lending, let your accountant do what they want.  But if you are thinking of buying a building, a big expansion or selling your business – have a chat with your accountant about planning to leave some meat on the bones for at least 2 years in a row.

Also, if you really want to impress all of the audiences prior to a big move mentioned above – think about switching to Review Engagement quality financial statements prepared by your accountant.  You pay more, but they will get you much further towards the lending/investing support you want, or the dollar you want to get for selling your business.

Whether you are a start up or an established firm, the options for financing a Canadian Small Business are few and far between.  The main options are:

Your Chartered Bank

• Their own suite of products
• Canadian Small Business Financing Loan (CSBFL) guaranteed by the Government of Canada

BDC  Business Development Bank of Canada

• Term lending, subordinated financing and some venture capital (mostly for large biotech)

Women Entrepreneur Associations who receive funding from Government

• AWE in Alberta and Women’s Enterprise Centre in BC for example

CYBF- Canadian Youth Business Foundation
A factoring agent (if you have high Accounts Receivables)

•           Maple Trade Finance
•           First Vancouver Financial
•           Pyx Financial

Leasing Agents (for equipment and other items)

Aboriginal programs

•           ABC Aboriginal Banking Corporation

Private Investors  – Angel investors or family

It is important to understand the main factors considered when you are going to obtain debt or investors.

• Personal credit score
• Equity in the business
• Cash-flow of the business (or projections)
• Collateral/Security
• Historical financial statements/ Strength of the business plan
• Personal Credit Score

Each of the above options for financing value the 5 pieces of information differently in their assessment of your application.  One thing common among them all, is the PRIMARY concern with all of the above is your PERSONAL credit rating.  Why do they care so much about how you spend your own money and handle your own debt?  This is because there is over 100 years of research and observations, which have shown that people pay their personal bills the EXACT same way they handle their business bills.  If you are late paying your credit cards, it is safe to assume you will be late in paying your business loan.

Lets get into your personal credit score a bit more here, because really, if you dont have that in proper order, you can forget about the other 4 points for consideration.  You are dead in the water  OR you can go find some partners or co-signers who DO have good credit.

Start up business  If you dont have at least a 725 Beacon Score (an Equifax risk rating product that some banks use to get a score for your personal rating), forget about getting a start up loan from traditional sources.  Some sources above care a bit less about your personal credit score.  They are the women focused lenders (your company has to be owned 51% by a female who is highly involved), the youth focused initiatives (CYBF) and the aboriginal programs (ABC).  Other than that, you will need to find a partner or co-signer with an extremely high credit score to take the average.  If your partner has an 800 score and you have a 700 score, the average between the two will be 750.

Existing business  since you have accountant prepared financial statements to back up your application, getting financing for your business will be much easier than if you were a start up company.  That being said, they give the weight they put on your personal credit score a break.   As long as you are over 650, feel free to go ahead and apply to traditional sources.  However, your chances of obtaining will still be lower than if your personal credit score was 700 or above.

Now that you have your credit score ironed out, lets move on to the next important items for consideration on your application.

Equity in the Business

Not sure what equity is? You arent alone.  Not many small business owners understand what the bank means when they speak about equity in your business.  Again, equity is different whether you are a start up business or an existing business.  Basically, a bank or an investor is just partnering with you to help you achieve your dream or project.  It is YOUR dream.  They are just helping you (for a fee!).  They do not want to take on all of the risk, and they want to make sure that YOU are dedicated to YOUR dream.  That is what equity is  your skin in the game.

Equity in a start-up

Because the business is not worth anything yet (because it is just starting!), you dont have any equity.  The only equity your start up business has is your cash investment.  Cash is cash is cash.  When the bank asks for your cash investment, they MEAN CASH!  It does not mean a cash advance from your credit card  that is just more debt.

To set your expectations on finding money for your start up business, fully expect the banks to hate it.  No one wants to finance a start up business.  50% of all start ups fail, no matter HOW good you think you are.

That being said, the banks will most likely only finance your start up under the CSBFL loan as the government guarantees almost all of the loan (they will pay the bank if you dont).  This option will mean you will have to put in less of a personal guarantee (security) as the government will be their recourse for payment recovery.  Your personal guarantee (for what you are on the hook for during recover) is usually limited to 10% on CSBFL loans.  You will be required to put at least 30% equity (cash investment) into the project.  The banks are aiming for a debt to equity ration of no more than 3:1.

BDC will also consider start up financing, but they are not receiving any government guarantee.  You should expect to me on the hook with a 100% personal guarantee as well as expecting the debt to equity ratio more at a 2:1 level.

Equity in an Existing Business

You equity in your business is your Retained Earnings + Your Shareholder Loans balance  goodwill and intangible assets.  You can easily calculate this number of off your last financial statement prepared by your accountant.  At any time, you should expect to be able to leverage this equity (lend against it) for 3 times your equity.  To repeat again: You can borrow up to 3 times debt, the amount of equity you have.

Cash-flow of the Business

You will need to do financial forecasting for at least 2 years into the future.  This will show what you expect the revenue of the company to be, as well as the expenses.  Simply take your profit and loss statement (Statement of Earnings or Income Statement) and dump it into an excel file.  Make new headings for the next two years and guestimate (with reasoning for your guesses) as to how you expect revenues and expenses to grow or decline.

These numbers will be used to gauge the ability of the business to pay back the lending you are applying for.  You can make the case that based on past records, the business can not pay for the new piece of equipment, but with the new equipment, sales will increase 10% and expenses of outsourcing will decrease by 30% and you will actually be able to make the payments and make more profit.

If you are a start up, you only have projections of cash flow to back up your cash.   Existing businesses have their cash flow and their historical statements to back up their application.

Collateral or Security

This is the area that is mostly confused with equity.  Collateral and security are the items of recourse for the bank to cling on to when you have declared bankruptcy, have gone out of business or are no longer able to pay your commitments.

Forms of security and collateral are personal guarantees, mortgages on land and buildings, general security agreements with a blanket charge on everything the business owns, as well as many other types of legal documents.

Typically, when the lender is able to take a charge on an asset (such as equipment) they devalue it to the point they believe they will receive in a liquidation scenario.  For example, on general equipment you will receive just less than 30% of its value as collateral value.  However, the more security value you are able to give to the lender, the better your interest rate (pricing) will be.

Historical Financial Statements

The major mistake many companies face, is they have their accountant prepare their year-end documents to try to minimize the taxes they will pay.  This is fine to a degree, but not at the expense of making your company un-bankable.

Making your company un-bankable means that you have made financial decisions that when presented on paper, make your business look like it is performing way under the level it may actually be in reality.

For example, you may start out with a net profit at the end of the year of $200K.  Once your accountant gets done with it, they may write off your personal vehicle expense, rent, and anything else they can run through the business.  You may be left with $20K in profit.

Now you want to go to the bank and get a loan for that large piece of manufacturing equipment that will set you up for great things for the next 5 years.  The cost of the equipment is $100K.  The bank would look at doing that over a 5 year amortization.  That is $20K per year in principal expense.  That doesnt even include interest!  With only a net profit of $20K a year out of the business, how is the business supposed to pay $20K + interest in additional expenses?  It cant on paper!  Your loan will most likely be denied.

It is important to get your fair share of tax planning done, however do not strip out the earning of the company to make it look like a slow performer.  Also do not dividend out all of your equity out of retained earnings, as you will effect how much debt you are able to leverage.

The bottom line on financial statements is make sure that your company has a healthy bottom line, enough to support future growth or the need for debt repayment to support that growth.  Make sure you leave enough retained earnings in the company to allow room for leveraging it when you need to buy a building, or equipment or some more working capital.

Strength of a Business Plan

If you dont have historical financial statements to prove you understand how to run a profitable business, you will most likely be a start up.  Almost any lender will require a business plan.  This will allow them to understand how you intend to run the business, how you understand your competition, what your marketing plan is, as well as how your skills, experience and education will help you manage the business.

How The Global Office Can Help

The Global Office can assist you in writing a business plan, or preparing the financial projections.   Also, if you need help knowing where and how to fix your personal credit score, contact The Global Office.    www.theglobaloffice.ca