From loss to profit at the stroke of a pen!

For the second time in a couple of months I’ve come across a business unable to arrange finance because it didn’t properly understand the way it had presented financial information to prospective lenders.  Once corrected, and more importantly, properly explained, finance was available on significantly better terms.

I’m not a tax practitioner* but my understanding is that it is perfectly legitimate for income tax purposes to value closing inventory at cost.  Doing so will defer the recognition of taxable income until the inventory is sold, likewise deferring the income tax bill – which is clearly extremely helpful in managing the cashflow of a growing business.

For businesses that carry the same amount of stock, year in-year out, the income tax treatment will “catch up” to the accounting treatment and there won’t be much difference in the medium term.  But for businesses that are growing, or have variable stock levels, the difference can be quite significant.

In case 1 the treatment turned a healthy business into one that was marginally profitable, in case 2 it turned modest profits into large losses.  Significantly, it also meant that the projected gross margin was much higher than the historical gross margin.

In both of my recent cases, the external accountant had used the treatment without explaining it in a way that their client understood. That meant that the client was unaware of the need to explain the historical effect to lenders, and completely unable to explain the projected increase in gross margin, which, to a cynical lender, seemed to “magically appear” just when the borrower needed finance.

To have finance declined is bad enough, but even worse, I have also seen the same situation result in a borrower being transferred to “bad bank” – and then being asked to refinance.

The business banker of yesterday had the time to get into the numbers. In my examples, they may well have been able to work out what was going on, and “turn it into a deal.”  However, most of the bankers I meet today have many more opportunities than time to analyse them, and so deals that don’t appear to stack up are quietly put to one side, quite possibly without the potential borrower ever understanding why.   

More than ever, it is important for a prospective borrower have a well-written proposal that has already been “put under the microscope” and stress-tested, by an adviser that understands both banking and accounting, and how the two intersect.

*Take your own tax advice based on your own specific circumstances, please.

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