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.

Missing pieces

On 24 September the Treasurer announced that Australia’s response to COVID-19 would include a new restructuring process, intended to make restructuring cheaper and more accessible for the smallest businesses.

Only two weeks later the draft Corporations Amendment (Corporate Insolvency Reforms) Bill 2020 (Cth) was released, with perhaps the shortest consultation period on record – 4 business days!

The draft legislation is a jigsaw puzzle with many missing pieces.  There are several important and significant parts that have been left blank, to be completed by later regulation.  Yes, it is possible to make educated guesses based on the Explanatory Memorandum and the Treasury fact sheet – but that is hardly a satisfactory way to review legislation.

One of the very pleasing aspects is that those responsible for the drafting have drawn heavily on the existing voluntary administration framework and definitions.  For that reason, many of the concepts and definitions are well developed and understood, and so we hopefully avoid the “what-does-that-mean” post-implementation chaos of the PPSR.

The process has been described as incorporating elements of the US Chapter 11 approach.  However, it’s not the big end of town Chapter 11, where every decision is made slowly and expensively in a Courtroom.  As White & Case explain, it draws on the “Subchapter V process,” and the key point is that the directors stay in charge of the business for all activities within the ordinary course of business.

Once appointed, a Small Business Restructuring Practitioner helps the directors prepare a restructuring plan.  It seems – but it’s not clear – that the SBRP will provide creditors with a recommendation to accept or reject the plan, which they will do electronically, with no physical meeting.  Between appointment and meeting day there will be a stay on creditor action which follows the voluntary administration moratorium.  

Mark McKillop summarises the detail we don’t have, noting that the regulations will specify:   

Surprisingly, nearly all of the functions, duties and powers of the restructuring practitioner.   There is a generic provision for basic functions like providing advice to the company on restructuring matters, assisting and preparing a restructuring plan, making a declaration to creditors “in accordance with the regulations” in relation to the plan and any other functions given to the practitioner under the Act.  Apart from that, the regulations are to provide…;

The form, content, making, implementation, varying, lapsing, voiding, contravention and termination of restructuring plans.    Regulations are also to provide for the role of the restructuring practitioner in relation to the plan….

At first glance, the proposed process is a cut-down version of voluntary administration.  It should be quicker and cheaper than VA, and there are eligibility restrictions which mean that a director can only invoke it on one occasion across all corporate involvements – so what’s not to like?

The biggest issue is that it is not clear whether small businesses will be able to access the process in practical terms:

  • The process is only open to companies up to date with “tax lodgements.” In the absence of the regulations it is not clear what that means – but potentially it may exclude companies with overdue income tax returns.

  • Companies are also required to have paid all “employee entitlements.” Again, it is unclear what that includes, but if it means that employee leave entitlements and so on must be paid out, that will impose a cash impost that will be too heavy for many businesses.

  • The SBRP has no liability for debts incurred after his or her appointment. That’s great for the SBRP – but many creditors will decide that it shifts the credit risk to them, and they may insist on CoD terms.  Businesses that can’t trade on CoD will be squeezed.

  • The remuneration for the SBRP is another aspect to be settled later by the Regulations – but it seems that the expectation is that there will be a fixed fee for the work up to the vote, and then a percentage commission on distributions to creditors for work done after the vote. If the Regulations do cap the fee and commission as some anticipate, then we might see SBRPs refusing an appointment because the work required to do the job properly is out of line with the fees available.

Within all the uncertainty there is the framework of a useful process.  Time will tell if the fleeting consultation process provides sufficient time to identify and iron out the wrinkles.  If it does, we will have a useful low-cost option added to the toolkit.