Accountants For Small To Medium Sized Businesses
Xero cloud accounting, Certified Advisor
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9.1 Is your business solvent?
9.2 Is your business profitable?
9.3 Gross profit margin
9.4 Calculating your breaking-even point
9.5 Net profit margin
9.6 What is your return on assets?
9.7 How is your business performing in key areas?
9.8 The borrowing ratio (gearing)
9.9 Average collection period (debtor days)
9.10 Creditor days
9.11 Stock turnover
9.12 Overheads as a percentage of turnover
Most small business proprietors lack detailed bookkeeping knowledge, and have neither the time nor the inclination to learn it! Even though there are many small business accounting software packages out there; without the knowledge of basic accounting concepts you may find they can be potentially dangerous. The inherent complexity of such systems may lead to errors, as well as require a lot of time in trying to learn how to use the system, and in coping with the frustration and expense of trying to sort out any problems. Furthermore, without a detailed knowledge of accountancy, proprietors may not be able to make use of many of the features and reports. Would you expect an electrician to plumb a bathroom correctly and to a code of compliance; probably not and that's what could happen to business owners who do their own bookkeeping. Am I being biased? For sure! I have invested a lot of time and money in the profession of business bookkeeping to ensure the jobs done right!
One of your first important decisions will be on how to structure your new business. Ownership structures influence tax effectiveness, asset protection and can play a major part in achieving flexibility for the future.
The New Zealand Companies office gives some good information on the different business structures available including advantages and disadvantages. Go to http://www.companies.govt.nz/cms/how-do-i/learn-what-a-company-is/choosing-a-business-structure
If you are registered for Goods and Services Tax (GST) you must account regularly to the Inland Revenue Department (IRD). The "accounting basis" is the method by which you account for GST. There are three options from which to choose:
the invoice basis
the payments basis
the hybrid basis
Under this basis, you account for or claim GST for a transaction in the tax period in which the invoice is issued, as opposed to the period in which payment is received or made.
In general, you will be required to hold a tax invoice in order to claim a tax credit for transactions of more than $50 (including GST).
You will have to keep a list of debtors and creditors as at the end of each period. This is because you will have to show a record of items sold and received, and these will not be reflected in your cash statements.
The perceived advantage of the invoice basis is that, if you are the buyer, you can claim GST on a purchase before paying for it. Conversely, if you are the supplier the disadvantage is that you must account to the IRD for GST before receiving payment.
Using this method involves accounting for GST for a transaction in the taxable period in which you make or receive payment.
As with the invoice basis, you will generally be required to hold a tax invoice in order to claim a tax credit for transactions of more than $50 (including GST). Unlike the invoice basis, you do not account for debtors and creditors at the end of each taxable period.
There are restrictions on who may use the payments basis. It can be used by any registered person if any of these criteria apply:
The total value of taxable supplies for the last 12 months was $1.3 million or less.
The total value of taxable supplies is not likely to be more than $1.3 million in any 12-month period beginning on the first day of any month.
The payments basis would be the most appropriate one to use, taking into account the nature, value and volume of taxable supplies and the accounting system used.
The perceived advantages of the payments basis is that in supplying goods and services you need to account for GST only when you have received payment. Conversely, as a buyer you cannot claim GST on purchases until after you have paid the supplier. The payments basis is seen by the IRD as suitable for small businesses currently using the cash system, because their cash books can easily be amended to account for GST.
The third option is the hybrid basis, which can be used by any person or business registered for GST. As the name suggests, the hybrid system combines the invoice and payments system, in that the invoice basis is used to account for GST on your sales while the payments basis is used for your purchases.
Because the invoice system is used for your sales, you will need to keep a list of your debtors as at the end of the taxable period. Because the payments basis is used for your purchases, there is no need to keep a list of your creditors.
Businesses must operate within the New Zealand laws and regulations governing commercial activities and practices. Select the link for an introduction to the key legislation, regulations and compliance requirements your business may need to know about http://www.business.govt.nz/Business-regulations.aspx
Click on the link below to see what expenses can be claimed by your business
IRD - Entertainment and Travel Expenses
Registered companies cannot escape the solvency test
Directors must consider the solvency test before paying dividends to shareholders.
If a company does not satisfy the solvency test, the distribution can be clawed back unless the shareholder acted in good faith with no knowledge that the company was insolvent, and it would be unfair to require repayment in full.
Directors can be personally liable if the solvency test procedure it not followed, or reasonable grounds did not exist for the decision. Many closely-held companies do not bother with minutes and other formalities; putting the directors at personal risk, particularly from creditors, by ignoring these formalities. Fines and penalties can be imposed on the directors.
For more information on directors responsibilites go to
You can monitor your business’s performance with tools called key accounting ratios, which help you to interpret financial information about your company. The more you know about how your business is performing, the easier it will be for you to make informed decisions about how to manage and grow your business.
The guide explains key ratios to help you address these vital issues:
What is your return on assets?
How is your business performing in key areas?
The records you keep can provide a great deal of information about your business and its performance. Details of sales made to customers, purchases made from suppliers and payments made to employees can all be used to see how the business is doing.
Just as importantly, the information can be used to compare the performance of the business with its previous track record and with the performance of other similar businesses. You can also make comparisons to review how profitable the business is, how efficiently it is performing, and whether it is able to pay its bills on time.
This guide shows you what to monitor and how to interpret key financial information about your company. Remember that with most of these measures, the trend over time is often more revealing than one figure in isolation.
Is your business solvent?
A business is considered to be solvent when it can pay its debts as they become due. In day-to-day terms, this means it can pay its suppliers by having enough working capital.
There are two key ratios that help us determine whether a business is showing a solvent position:
Current ratio and
Quick ratio (sometimes called acid test ratio).
Current assets include: stock, debtors and cash. Current liabilities include: trade creditors, current tax liabilities, bank overdraft and so on. The word “current” implies short-term assets or liabilities, payable or receivable within one year.
If current assets totalled $40,000 and current liabilities $20,000, then the current ratio would be: Current ratio = $40,000 ÷ $20,000 = 2:1
This would be considered a healthy result showing you have enough current assets to pay current liabilities as soon as they are due.
Historically, a ratio below 2:1 would have given cause for concern about the ability of a business to meet its debts and trade successfully. Today, businesses tend to work within a ratio of 1:1.
Using the figures from the example shown for the current ratio, and assuming the value of stock to be $10,000, we see the quick ratio would be:
Quick ratio = ($40,000 - $10,000) ÷ $20,000
= $30,000 ÷ $20,000 or = 1.5 :1
Historically, this would be considered a satisfactory result, but here too, businesses are tending to work with a lower ratio.
When reviewing the liquidity of a business, it is common practice to look at both the current ratio and quick ratio. For example, a business may look healthy using the current ratio, but this won’t show if it’s carrying too much stock. An apparently healthy level of current assets might hide the fact that a large proportion of the current assets is made up of stock. Stock can usually be turned into cash – but only over time, and to do it quickly might require discounting.
You can see if your business is profitable by preparing a profit and loss account, but you need to put that profit into perspective. Ask yourself:
Is the profit growing in proportion to the size of the business?
Is the profit growing or falling in relative terms – are you making as much profit on extra sales as you were on existing sales?
Is the business as profitable as other businesses in the same sector?
The size of a business is often measured by looking at:
Levels of turnover.
Value of assets.
Amount of capital invested in the business.
Number of employees.
You can put the profit in perspective by looking at various ratios which compare profit as a percentage of sales or assets.
One of the most commonly used ratios is the gross profit margin, which looks at gross profit as a percentage of turnover: Gross profit % = gross profit ÷ turnover x 100
So if a business makes a gross profit of $45,000 from sales of $135,000, the calculation will be: Gross profit % = $45,000 ÷ $135,000 x 100 = 33%
This means that for every $1 of sales the business achieves, profit after taking off the costs of production is 33cents. Small changes in this percentage can indicate that your costs of production are creeping up, which should prompt you to consider increasing prices or looking for cheaper suppliers. Your gross profit margin is not the same as your mark up, which is calculated as follows: Mark up = gross profit ÷ cost of sales x100
So for the previous example, the mark up would be: Mark up = 45,000 ÷ 90,000 x 100 = 50%
Your gross margin can also be used to calculate your break-even point, i.e. the level of sales you need to achieve to make a profit: Break-even = fixed expenses ÷ gross margin
For example, for a business with fixed expenses of $50,000 and a gross margin of 40 per cent, break-even would be at $125,000 of sales. (50,000 x 40% = 125,000)
This ratio is similar to the gross profit margin but looks at net profit as a percentage of turnover. Net profit % = net profit ÷ turnover x 100
For example, if the business makes net profits of $20,000 from a turnover of $100,000, the net profit percentage would be calculated like this: Net profit % = $20,000 ÷ $100,000 x 100 = 20%
This ratio provides a good measure of performance, but if the percentage is declining, it is subject to many variable elements, making it difficult to correct. The net profit is calculated after taking account of all costs and may be affected by a declining gross profit or by increased selling or administration costs within the business. If your net profit percentage is declining it is worth looking at your costs on an individual basis to see what you can do about those that have increased the most proportionally. It is important to look at the trend which emerges over several accounting periods, as opposed to individual figures. The ratios can be used to measure periods other than a full year, as long as you have the data to work out the figures.
You can also measure the level of profit compared to the value of net assets invested in your business. The assets are the major items that need to be in place to do business, including fixed assets (buildings, plant, vehicles, computers) and current assets (stock, debtors, cash). The net asset total looks at total assets less liabilities. This represents the amount of capital invested in the business. You can therefore look at the net profit as a percentage of capital employed. The return that a business can expect differs by business sector and varies over time, depending on the economic cycle. However, it remains a good measure of business efficiency. The ratio is calculated: Return on assets = net profit ÷ net assets x 100
If the net profit was $20,000 as shown in the profit and loss account, and net assets were $200,000, then the return on assets would be: Return on assets = $20,000 ÷ $200,000 x 100 = 10%
There are several ratios which you can use to measure how individual aspects of a business are performing. You’ve already looked at the big measures – can you pay the bills as they fall due? Are you making the sort of profit at the gross or net level that you used to, or expected to? But by looking at individual parts of the business, you can gain more insight into profitability and efficiency.
These ratios include:
Average collection period.
Overheads as a percentage of turnover.
This ratio looks at total borrowings divided by net worth of the business. The idea is that the relationship between borrowings and equity should be in balance, with equity being significantly higher than debt. For example, if your borrowings come to $30,000 and the business’s net worth (as shown in the balance sheet) is $90,000, then the borrowing ratio would be 1:3. This would be positive: usually bankers and financiers like to see this ratio at a level of at least 1:1.
This ratio is used widely within businesses to measure the effectiveness of a debt collection routine. It sets out the relationship between debtors and the sales that have been made on credit, and also shows how quickly customers are paying their invoices.
The calculation is: Debtor days = debtor’s ÷ turnover x 365
This ratio gives a rather broad-brush calculation. A more detailed calculation would look at how many days’ turnover it took to make up the debtor total.
Current debtors – $50,000
Sales in current month (exclud GST ) – $30,000
Sales in previous month (exclud GST) – $40,000
Debtors therefore represent all of the current month’s sales and half of the previous month’s sales.
If the current month includes 31 days, and the previous month was 30 days, total debtor days would appear:
Current month – 31 days
Balance from previous month: $20,000 ÷ $40,000 x 30 days – 15 days
Total debtor days – 46 days
If this ratio starts to increase, look carefully at your debtor collection routines. Are your customers taking a long time to pay you? Is one of your customers building up a large debt? If the answer to either of these questions is yes, then you should probably take action sooner rather than later. Don’t forget, the older a debt becomes, the more likely it is to go bad.
This ratio sets out the number of days taken to pay suppliers. This is less important than the debtor day statistic, as in this case the control over payment of suppliers is in your hands. When assessing another business, for example one that is asking you for increased credit, this ratio can give a useful pointer as to whether the business is taking longer to pay people. Outside credit reference agencies use the calculations to give a profile of the business to potential suppliers looking for details about a business.
The ratio is calculated: Creditor days = creditor’s ÷ purchases x 365
This ratio looks at how quickly you turn over stock into sales, and is another good measure of efficiency: Stock turnover = cost of goods sold ÷ stock value
For example, if the cost of goods sold is $50,000, and the average stock held during the year is $10,000, then stock has been “turned over” five times during the year.
A quick turnover suggests that the business is efficient in holding the minimum stock used within the business. Again, the trend over time is very important. If your stock turn is slowing, this may highlight a problem with slow-moving lines which may require discounting to sell through.
Again, reviewing overheads in relationship to turnover can be a useful tool in assessing whether they are growing more rapidly than they should. The calculation is overheads ÷ turnover x 100
The calculation means little on its own, but when reviewed over several periods it can provide useful trend information. As the business grows, this percentage should fall. If it doesn’t, then you need to review your overhead costs carefully to understand why this is happening and see what you can do to correct it. For example, if your telephone or utility costs are increasing, you may want to think about switching suppliers.
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