Tuesday, 08 October 2019 10:52

Failure To Pay Taxes

Benjamin Franklin said, “There are only two certainties in life – death and taxes”. Whilst failure to pay the second shouldn’t lead to the first, it can cause significant problems for individuals, as outlined in a recent Court decision.

Nicola Joy Dargie was sentenced to two years six months imprisonment for failing to pay PAYE deducted from employees’ salary to the IRD.

Ms Dargie’s explanation for the non-payment of $740,000, which occurred over a period of 10 years, was that she had withheld the tax payments from the IRD to keep her employees in a job.

It is a practice that we encounter on a reasonably regular basis in liquidations - directors using the amounts they have deducted from their employees’ wages for things such as PAYE, Kiwisaver, Child Support and Student Loans, to boost the cashflow of their business. Their priority being to keep suppliers paid so they can continue to employ staff.

There are several problems with this course of action.

First and foremost, the funds are not the directors, or the company’s, to spend. They are the employees’ funds deducted from their wage entitlement for specific purposes and should be held in trust.

Secondly, there can be severe penalties imposed on directors who follow this course, as evidenced by the sentence imposed on Ms Dargie.

Thirdly, even if the intention was that the payments would be withheld for only a short time, to get through a tough trading period for example, the penalties and interest charged by the IRD for non-payment are at such a level that it does not make economic sense to do it. It would be better (and safer) to go to the bank for a short-term loan.

By continuing to operate a business that is not able to pay its debts, including taxes, as they fall due, directors expose themselves to potential claims against them personally that they have breached their duties as directors by trading whilst insolvent.

The amounts deducted from employees’ wages, and, to a similar degree, the GST collected on sales, are not funds available to a company to cover operating expenses and pay trade suppliers. These funds should be put into a separate account and only accessed to pay to the IRD as they fall due.

If directors find themselves in the position of having to dip into those funds to pay other expenses, then they need to review the financial position of the company to assess its on-going viability.

If you are in arrears with PAYE you are in a far better position if you consult with IRD and reach an instalment plan on arrears. If hardship applies, then notify IRD early on. If the company is insolvent, consult an accredited insolvency practitioner.

If you would like more information or advice on managing tax payments and the solvency of your business, please contact one of the team at McDonald Vague.

Effective cashflow management is critical to any businesses survival and growth. Understanding your businesses underlying cashflows will help identify potential changes to your business processes that will improve cashflow, profitability and business value

A firm's ability to reliably spin-off positive cashflows from the firm's routine business operations is one of the key factors business owners and potential investors look for.

Cashflow Defined

Cashflow is typically defined as the net change in your firm’s cash position from one accounting period to the next. If you generate more cash than you consume, you have a positive cashflow. If you have greater cash outflows than inflow, you have a negative cashflow. Thus, your cashflow is a key indicator of a firm’s financial health.

Understanding Your Cashflow Statement

Operating cashflows illuminate a company's true profitability. It's one of the purest measures of cash sources and the use of cash within a business and is the launching pad for complementary financial statements and reports.

Operating cashflow is a fundamental part of your cashflow statement. Your cashflow statement illustrates the fluctuations in cash compared to less volatile equivalents such as shareholders' equity and the balance sheet.

Your cashflow statement details both where cash is being generated and consumed in the business over a set period of time.

By taking the net income figure from the firm’s income statement and adjusting it to display variations in the firm’s working capital defined as payables, receivables and inventories as reflected on the balance sheet, the firm’s operating cashflow line item illustrates the sources of cash spun off during the reporting period.

Cashflow Sources

A business’ sources and uses of cash are typically split into categories covering operations, investments and financing activities.

1. Operations: Reflects a firm's operational cash inflows and outflows, the net effect of these defines a firm’s operating cashflow position
2. Investments: Shows changes in the businesses’ cash position from the divestment or acquisition of property, plant and equipment or other typically longer-term investments
3. Finance: Captures changes in cash levels from the share buyback schemes or bond issues, together with interest payments and dividend distributions to shareholders.

Operating Activities

A firm’s operating activities comprise its routine core commercial activities within the business that generates cash inflows and outflows. These operating activities typically include:

1. Sale of goods and services recorded during an accounting period
2. Supplier payments covering goods and services consumed during the production of outputs recorded during an accounting period
3. Employee payments or other expenses incurred during an accounting period.

To establish the significance of underlying material changes in a firm’s operating cashflows, it is useful to be familiar with just how a firm’s cashflow is estimated. Two models are generally used to tally cashflow generated by operating activities. These are the Indirect and Direct models.

Direct Method: Uses information derived from the income statement based on cash receipts and cash outgoings generated by the businesses’ operations.

Indirect Method: Adopts the firm’s net income and derives its OCF by incorporating those line items used to determine the firm’s net income but which did not affect the firm’s actual cash position.

Operating Cashflows

Your operating cashflow is a very useful assessment tool as it assists business owners to understand the firm’s fundamentals. For many owners, the OCF position is considered to be the cash component of net income, as it purges the firm’s income statement of non-cash related items and non-cash based expenditure such as amortization and depreciation and changes to the firm’s current assets and liabilities position.

Operating cashflows is a more accurate indicator of underlying profitability than measures of net income, as it is less open to massaging the operating cashflows to window dress profitability.

Cashflow As A Business Diagnostic

A cashflow statement is much more than simply a snapshot of your business’ financial health. They can also be used as a powerful management tool to affect positive change within your organisation.

Business owners can use a cashflow statement to evaluate their firm’s strengths and weaknesses, helping them to chart a savvy and more efficient path forward. Used the right way, a cashflow statement can show an owner how efficiently the business is harnessing its cash while identifying which areas are absorbing more cash than they generate.

This information can be critical to ensuring the firm’s survival while providing a point of focus for growth initiatives. Cashflow is also a useful indicator of how efficient an internal business process is and how dynamic a firm’s products or services are.

By identifying changes to a firm’s internal business processes that will improve the firm’s underlying cashflow, profit, and business value, a business owner can drive innovation, lift productivity and effectiveness levels and cull under-performing products.

When a firm enjoys robust operating cashflows with more cashflowing in than flowing out, the owners know they have a healthy business. Companies with solid operating cashflow growth are more likely to enjoy predictable net income levels, together with an enhanced ability to pay suppliers and reinvest in the business.

Robust operating cashflow also provides more opportunities to expand the business and to cope with fluctuating economic conditions, turbulence in their industry or adverse weather events.

Final Observation

A firm’s operating cashflow is simply one aspect of a firm's cashflow position. Cashflow is also one of the most insightful measures of a firm’s financial viability, underlying profitability and its long-term prospective outlook. Cashflow measures a company’s incoming and outgoing cashflows over a nominated accounting period. Cashflow is also a useful tool for identifying inefficient processes and under-performing products or services. If you truly identify with the "Cash is King," mantra, then robust operating cashflow is one of the most reliable key indicators to look for when assessing a firm.