To help establish a good working chart of accounts you need to answer some questions, in conjunction with your accountant, as to how your business will operate and what is important to you. Some of these considerations might be:

1. Will your business have stock to account for? If so, will it be purchased in finished form or will there be production costs?
2. Are fixed assets a significant portion of your business?
3. Will you sell only one product or service or will there be several types of business?
4. Will you have accounts receivable from customers, which you will have to track?
5. Are you going to sell in only one location or will you do business in several places?
6. Are the products you sell subject to value added tax?
7. Do you need to track costs by department?
8. What type of government controls or regulatory reporting are you subject to?

Each one of these questions can have several answers and will probably generate more questions. Each answer will have an impact on how the chart of accounts is structured. It may seem that developing a chart of accounts is not particularly high on your list of things to do as you start a new business; the amount of time and money which a well organised accounting system may save you can be significant as the need to generate information for various purposes increases. An example of a basic chart of accounts follows this section.

Cash or Accrual Accounting (Back to Top)

One of the decisions to be made as you start a business is whether to keep your records on a cash or accrual basis of accounting. The cash basis of accounting has the advantage of simplicity and almost everyone understands it. Under the cash basis of accounting you record sales when you receive the money and account for expenses when you pay the bills. The increase in the money in “the cigar box” at the end of the month is how much you have made.

Unfortunately, as we all know, the business world is not always so easy. Sales are made to customers and you sometimes must extend credit. Your business will incur liabilities which are due even though you may not have received the invoice or have the cash available to pay them.

Most users of financial statements such as bankers and investors are used to accrual-basis statements and expect to see them. Once you become familiar with them, they provide a much better measuring device for your business operations than cash-basis statements.

Whether you use the cash or accrual basis, it is possible to keep books for income tax purposes on a different basis than for financial statements. It may be more advantageous (less tax) for you to do so. DNA can advise you on the advantages and feasibility of doing this in your particular circumstances.

Accounting Records and Record-keeping (Back to Top)

Another question that the owner of a business must answer is “Who will keep the books of the business?” Will you do it yourself, will the receptionist or a secretary double as a part-time bookkeeper, will you have a bookkeeper that comes in periodically, or will the volume of activity be such that a full-time bookkeeper will be required?

Very often the owners of a business decide to keep the books themselves and underestimate the commitment they have made to other phases of the operation and the time required to maintain a good set of financial records and books of account. As a consequence, the record keeping is often low priority and must be caught up later. This approach, though rarely planned, can require a substantial expenditure of time and money. While it is important for the owners of a business to maintain control and stay involved in the financial operations of the enterprise, this can be achieved by maintaining close control over the cheque-signing function and scrutinising certain records. Your company’s accountant can help develop a good programme of record-keeping duties for you, your employees and any outside book-keepers or accountants you may engage.

A Word about Computers (Back to Top)

The computer is probably the single, most valuable, invention for bookkeeping and accounting since the advent of double entry bookkeeping. If your business includes any of the following, then a computer would be a useful tool in your business:

1. Many repetitive or routine tasks.
2. Lots of paperwork, i.e. suppliers’ cheques, sales invoices, purchase orders, mailing labels.
3. Lots of general correspondence.
4. Written reports, contracts, newsletters, catalogues or brochures.

DNA know about both your business and computers and can take much of the confusion out of the selection process by assisting you in the purchase and installation of your computer.

There are a number of very good, easy to use, accounting software systems which are commercially available, but none of them will solve the problems of inaccurate or poor quality financial records. All they will do is generate bad information faster. This is one of the reasons that the computer has also probably caused more headaches for the owners of modern businesses than any other single cause. If you want to use a computer-based accounting package, either in your own business, with a service bureau, or through your accountant, it is imperative that you generate accurate information to be entered into the system.

The real value of the computer becomes apparent once it is running smoothly in your business. Your accountant can then function in the capacity for which he was trained, not as a “number cruncher”, but as your business adviser, consultant and strategist. Both of you can focus not on producing reports for various regulatory agencies but on analysing your business to make it more profitable.

Internal Control (Back to Top)

What is internal control? It is the system of checks and balances within a business enterprise that helps to ensure that the company’s assets are properly safeguarded and that the financial information produced by the company is accurate and reliable. When you are operating as a “one man shop” or at least handling all of the company’s financial transactions, maintaining good internal accounting control is relatively straightforward.

However, when your company grows to the size where you must delegate some of the functions, it becomes more difficult to ensure that all the transactions are being accounted for properly.

No matter the size of your business, you should always be able to answer “YES” to the following questions:

1. When my company provides goods or services to our customers am I sure that the sale is recorded and the debt is recorded in accounts receivable or the cash is collected?
2. When cash is expended by my company am I sure we received goods or services?

The method used to ensure that these two questions can be answered affirmatively will be widely varied. They are essential stepping-stones to maintaining good control in your business. The solution in your particular instance may be as simple as numbering the sales tickets and being sure ALL TICKETS ARE ACCOUNTED FOR or reviewing all invoices and timecards before signing company cheques. These are fundamentals in a well-run business. As the company grows you will need to consider concepts such as segregation of authority as well as employee fidelity bonds or controlled access storerooms.

No matter what the size of your enterprise, you should consider controlling your business and safeguarding hard earned assets as a priority from the outset.

FIXED ASSETS - TANGIBLE
0010 Freehold property cost
0020 Freehold property depreciation
0110 Leasehold property cost
0120 Leasehold property depreciation
0210 Plant and machinery cost
0220 Plant and machinery depreciation
0310 Fixtures/fittings cost
0320 Fixtures/fittings depreciation
0410 Motor vehicles cost
0420 Motor vehicles depreciation

FIXED ASSETS - INTANGIBLE
0700 Investments
0900 Goodwill

CURRENT ASSETS
1000 Stocks and work in progress
1100 Trade debtors *
1103 Debtors and prepayments *
1200 Bank current account *
1230 Petty cash *

CURRENT LIABILITIES
2100 Purchase ledger control *
2109 Creditors and accruals *
2200 VAT control account *
2300 PAYE/NI creditor *

LONG TERM LIABILITIES
2600 Bank loans
2700 Hire purchase creditors
2800 Lease purchase creditors
2900 Other loans

CAPITAL AND RESERVES
3000 Capital account - balance brought forward
3100 Capital introduced
3200 Profit and loss account
3300 Drawings

* denotes control accounts

SALES
4000 Sales/work done
4009 Discounts allowed
4100 Export sales

OTHER INCOME
4200 Royalties received
4210 Commissions received
4220 Insurance claims
4230 Rental income
4240 Bank interest received

COST OF SALES
5000 Purchases
5900 Opening stock and work in progress
5950 Closing stock and work in progress

DIRECT COSTS
6000 Direct labour
6100 Goods outward costs
6200 Goods inward costs
6300 Packaging
6400 Duty paid
6500 Transport insurance
6600 Sales commissions payable
6700 Royalties payable

OVERHEADS
7000 Motor expenses
7100 Telephone
7200 Wages
7250 Wife’s wages
7300 Rent
7400 Rates
7500 Heat and light
7600 Postage, stationery and advertising
7700 Repairs and renewals
7800 Insurance
7900 Bank charges and interest
8000 Hire purchase interest
8050 Mortgage interest
8100 Accountancy fees
8200 Legal charges
8300 Use of home as office
8400 Protective clothing
8500 Cleaning
8600 Sundry expenses
8700 Subsistence
8800 Profit on asset sales
8900 Depreciation
9000 Bad debt write off

There are two different types of registration - compulsory and voluntary:

A. Compulsory
A person who makes taxable supplies becomes liable to be registered if:

1. At the end of any month, the value of his taxable supplies in the period of one year then ending has exceeded the registration limit, which is £61,000 from 01 April 2006.
2. At any time, there are reasonable grounds for believing that the value of his taxable supplies in the next 30 days will exceed the £61,000 limit.
3. If, where a business carried on by a taxable person is transferred as a going concern, the taxable supplies for the twelve months prior to the transfer exceed £61,000.
4. In the most common situation, i.e. (i) above, the person must notify Customs & Excise of the liability within 30 days of the end of the month in which the value of the taxable supplies first exceeded £61,000. If, for example, the value of the taxable supplies first exceeded £61,000 in the twelve months to 31 March, then Customs & Excise must be notified by 30 April and VAT registration would commence on 1 May.

B. Voluntary

In certain circumstances, it is possible to register on a voluntary basis for VAT even though the value of taxable supplies may never exceed £61,000. This is normally only beneficial where the majority of supplies are being made to customers who are themselves VAT registered, e.g. it would not be beneficial for a domestic painter with taxable supplies of £30,000 to be registered, whereas it would be beneficial for a commercial or industrial painter with the same level of supplies.

The other situation in which a voluntary registration might be beneficial is where the supplies are all zero-rated and no VAT is charged on the transaction. All VAT suffered by the trader on expenses can be reclaimed from Customs & Excise.

In summary, the advantages and disadvantages of a voluntary registration are as follows:

Advantages

• enables input VAT suffered to be reclaimed;
• a VAT number can give the impression that a business is larger than it actually is which sometimes can increase the possibility of obtaining work.

Disadvantages

• the requirement to prepare VAT returns on a quarterly basis and to submit them within one month of the quarter end - is the amount of work involved worth it for the amount of input VAT that can be reclaimed?
• Customs & Excise may visit the business about every five years to ensure that VAT is being properly accounted for.

Taxable Persons and Supplies (Back to Top)

a) Taxable Persons

It should always be remembered that it is a person that is registered for VAT and not a business. If a person has two separate different businesses, both with taxable supplies of £40,000, then that person will be required to be registered for VAT and account for VAT at the appropriate rate on the total supplies of £80,000. It is possible to mitigate the effect of VAT by having one of the businesses operated by a limited company or by a partnership with a relative, but professional advice needs to be taken since Customs & Excise have the power to still treat the two businesses as one if strict criteria are not met.

b) Taxable Supplies

Taxable supplies are all supplies made by a business either to a third party or to the trader himself (goods for own use), which are not exempt supplies. Taxable supplies therefore include zero-rated supplies. The major categories of exempt supplies are:

• Land (but not buildings)
• Insurance
• Postal services
• Betting, gaming and lotteries
• Finance
• Education
• Health and welfare

It is important that at the outset of a business, a trader establishes the VAT status of any supplies being made to avoid mistakes, e.g. the services of a physiotherapist are exempt, whilst the services of an acupuncturist are standard rated.

There are three rates of VAT:

- two standard rates -

17.5%
5% - for certain supplies of fuel and power and sanitary goods

- zero-rated.

The four main areas of zero-rated goods are:

1. Food and agriculture (but excluding pet food and most catering);
2. Printed matter, including books and newspaper;
3. Young children’s clothing and footwear;
4. Passenger transport (but excluding hire cars, taxis and parking).

Any VAT charged by the business, whether at 17.5% or 5% is known as output VAT and the total charged or collected in the VAT quarter is payable to Customs & Excise.

Input VAT (Back to Top)

Input VAT is the VAT that you are charged on your business purchases and expenses (the other persons output VAT) and is normally recoverable in full by a trader who only makes standard rated or zero-rated supplies. Businesses that make some exempt supplies (known as partially exempt businesses) have different recovery rules. The total input VAT suffered in the quarter is deducted from the output VAT charged or collected and the difference is either the amount of VAT due to Customs & Excise or the amount repayable by Customs & Excise.

The majority of input VAT is recoverable but there are special rules for:

1. cars;
2. petrol supplied for private usage;
3. business entertaining;
4. goods sold under a VAT second-hand scheme.

To reclaim VAT you have been charged as input VAT, you must hold valid evidence that you have received a taxable supply, which normally means a valid VAT invoice from a registered trader showing his VAT number and the amount of VAT charged.

Special Events (Back to Top)

VAT was originally described as a simple tax but has gradually become more and more complicated over the last twenty years with changes to the operation of VAT every year.

It is not always possible to calculate each quarter’s VAT liability by merely deducting input VAT incurred from 7/47 of the sales income and professional advice needs to be taken in the following situations:

• Importing and Exporting - either within or outside the European Union;
• Partial Exemption, i.e. where a business makes some exempt supplies, all the input VAT
  incurred is not necessarily recoverable;
• Retail Schemes, i.e. where both zero rated and standard rated supplies are made
  which cannot be separately identified at the point of sale;
• Land and Property;
• Cash Accounting;
• Self-supplies;
• Second-hand schemes for motor cars, used boats, antiques, horses and ponies and others.

Penalties (Back to Top)

The impact of penalties has been considerably reduced since the early 1990’s and the possibility of any business suffering a serious misdeclaration penalty for an innocent error on their VAT returns is low.

The two most important penalties still in existence which every business should be aware of are:

1. Late registration penalty for not registering for VAT at the correct time. The penalty is based on a percentage of the VAT due between the date of registration and the date that the person was required to be registered and the percentage increases dependent upon the lateness of the registration. The penalty is in addition to the VAT that is due.
2. Default surcharge for traders that are persistently late in either submitting VAT returns and/or making payment of the liability due. The penalty is based on a percentage of the VAT due and is on a sliding scale.

VAT Checklist (Back to Top)

Registration

1. Should the business be registered?
2. Is basis of registration correct?
3. Are details on registration certificate correct?
4. Do procedures exist for notifying Customs and Excise of relevant changes?
5. Review position at regular intervals.

Preparation of returns

1. Has return been received? If not, then obtain duplicate from VAT Office.
2. Review sources of information.
3. Prepare draft return.
4. Check for accuracy and completeness.
5. Make payment (if outputs exceed inputs)

Input Tax

1. Do any restrictions on input tax exist?
   - If “Yes”, does an agreed method exist?
   - Does this method maximise input tax?
2. Are invoice additions and calculations checked?
   (c) Is input tax claimed at the earliest tax point?
   (d) Are all claims properly supported?
3. Ensure all supporting invoices kept.

Output Tax

1. Are all income heads reflected for VAT accounting?
2. Are all potential sources of notional supplies considered?
3. Are all potential sources of income (asset sales, etc.) covered by VAT accounting system?
4. Is VAT captured at the correct tax point?
5. Is VAT correctly applied where appropriate?

Money Laundering Regulations

HM Customs & Excise have responsibility for administering certain aspects of The Money Laundering regulations 2003 particularly relating to High Value Dealers (HVDs).

HVDs are those traders who may receive 15,000 Euros (approximately £10,000) in a single transaction or a series of linked transactions. The Regulations principally apply if cash or cash equivalent are offered in settlement.

If you believe you may be a HVD you should discuss this with your advisors or visit the HM Customs & Excise Website at www.hmce.gov.uk.

Further if you believe you may be affected by the Regulations as they related to regulated businesses you should discuss this with your advisors as the penalties for not complying are serious.

The Inland Revenue publish various booklets relating to how PAYE is operated and the legislation that you have to comply with. Not only do you collect and remit PAYE to the Collector of Taxes on behalf of the Inland Revenue, you also operate the sick pay scheme and maternity pay scheme for the DSS. You should run the PAYE scheme in accordance with the legislation and should you fail to comply then the Revenue or DSS will look to you for the tax or NIC you failed to deduct. This can be costly if you are unable to recover the tax and NIC from the employee.

Do you have employees? (Back to Top)

Whether an individual is an employee or not in a particular situation is a question of fact depending on the terms on which he works. The question of whether an individual is employed or self-employed is very important for the business “employing” him or her, as that business has to comply with the reporting requirements.

In certain areas the Inland Revenue has placed emphasis on reclassifying individuals claiming to be self employed and has issued leaflet IR56 entitled “Tax: employed or self employed”. This booklet sets out the questions that should be answered to determine the problem. If you have treated someone as self employed and subsequently after a routine visit from the DSS or Inland Revenue it is clear that they were employees, then the tax and NIC which should have been paid will be assessed on you. Therefore it is important to ensure when using the services of self employed people, that they are in fact self-employed.

If doubt exists as to the status of an individual, the situation can be clarified with the Inland Revenue.

The Operation of a PAYE Scheme (Back to Top)

Upon registration the Inland Revenue will send to you guidelines on operating PAYE, National Insurance, Statutory Sick Pay and Statutory Maternity Pay (employer’s pack).

Included will be a number of forms with which to operate the PAYE and NIC system. You should familiarise yourself with and have supplies of these forms, which are as follows:-

• P11 Deduction working sheet
• P46 Notification to the Inland Revenue where no code has been notified to the employer and application for coding
• P46 (Car) Notification of a car provided for the private use of an employee or a director
• P45 Details of employee leaving
• P14/P60 End of year return and employers certificate
• P35 Employer’s annual statement
• P38A Employer’s supplementary return
• P11D Expenses and benefits
• P9D Expenses payments and income from which tax cannot be deducted.

In order to calculate the amount of tax and national insurance due by an employee, the Inland Revenue will supply you with sets of tables. By reference to the “tax free” tables and an employee’s tax code you will be able to calculate the amount of salary that is not subject to tax. The difference between this figure and the gross amount is the employee’s taxable pay. This can then be calculated by reference to another set of tables. The employer’s and employee’s national insurance is calculated by reference to the gross pay with a third set of tables. Special rules exist for the calculation of national insurance for directors.

The tax and national insurance should be paid to the Inland Revenue by the 19th of the month following that in which the salaries were paid.

In most businesses, the directors, and often the employees, have benefits that are not immediately taxed through the PAYE system, the most usual being the provision of a car and possibly fuel. Class 1A national insurance contributions are due on the taxable value of these benefits in kind and are due on the 19 July following the fiscal year in which the benefits are made available. In addition, the Inland Revenue requires on an annual basis, a form P11D (Return of expenses payments and benefits) for all directors irrespective of income and all employees receiving remuneration including the benefit in excess of £8,500. For those employees earning less than £8,500 but who receive expense payments and benefits, a form P9D is required.

A form P46(Car) needs to be completed quarterly on 5 July, 5 October, 5 January and 5 April if any employees have been provided with or have changed their company car. Further details are given on the taxation of company cars in Inland Revenue leaflets IR132 and IR133. The Inland Revenue will still require form P11D to be submitted annually in addition to the P46 (car) forms.

Which Accounting Year Should I Choose?

If you expect profits to rise steadily year by year, in the case of sole traders/partnerships, an accounting date early in the tax year, for instance 30 April, might be best in the short term, because this will defer the payment of tax on your profit. However, it is important to consider what will happen when you retire. Any accounting date other than 31 March will cause a bunching of your tax liabilities because all your profit that has not been assessed prior to your retirement will be assessed for your final year. There are a number of ways to mitigate the effect of this. You could plan to retire on or shortly after the accounting date, and allow “overlap relief” to reduce the burden. You could build up a reserve to meet the liability, or use the higher profit to permit an abnormally large pension contribution.

On the other hand if you expect to make losses in your early years, an accounting date late in the tax year, for instance, 31 March, will ensure that you get tax relief for those losses as quickly as possible. You would then not be faced with the bunching problem on retirement referred to above.

It will also be necessary to bear in mind the seasonality of your business. As part of the profit for your first period of trading could be taxed twice, it would be unfortunate if a poor choice of accounting date were to accelerate the tax on the profit of your first busy period. In these circumstances it might be preferable to run your first accounts to a date just short of your peak period.

As ever, it is important not to overlook commercial considerations. Your bankers might want to see as healthy a profit as you can manage and this desire could conflict with tax planning. A solution would be to chose a tax efficient tax accounting date, and keep the bank happy with quarterly management accounts.

Tax Returns (Back to Top)

Companies

Companies are charged corporation tax at the rate applicable during the financial year (1 April - 31 March). Where a company’s accounts period spans two financial years the profits for the period are apportioned between the years.

There are special rules to calculate the tax rates applicable for profits falling between the small companies and normal rates, and are such as to ensure that the tax charge rises progressively.

Corporation Tax Pay and File was brought into effect for accounting periods ending after 30 September 1993 (for accounting periods ending after 30 June 1999, it became Corporation Tax Self Assessment). A company is required to make an estimate of its own liability to corporation tax and pay that liability by the normal due date, nine months after the end of the accounting period, without an assessment being raised.

The company is required to send its completed tax return (form CT600), accounts and tax computation to the Inspector by the filing date, which is 12 months after the end of its accounting period. Penalties will be charged if it is late.

Once the company agrees its liability with the Inspector, there will be a settlement of any balance due or overpaid. Interest will be charged or paid from the normal due date on the balance.

Sole Traders/Partnerships (Back to Top)

Sole traders and partnerships are charged income tax at the rate applicable during the fiscal years (6 April - 5 April). The rates are as follows:

There may also be a liability to Class 2 and Class 4 National Insurance Contributions, depending on the level of profit in each fiscal year. Class 2 contributions are at a weekly rate of £2.10 (2005/06). Class 4 NI is payable by the self employed on profits.

Class 4 contributions are levied at 8% on profits between £4,745 and £31,720 (max) for 2004/05 and profits between £4,895 and £32,760 (max) for 2005/06. There will be a further 1% charge on profits in excess of the upper limit of £32,760.

For the self –employed and those that pay tax on other income such as rents, tax is normally payable in three instalments - the first two instalments are based on the tax paid on the previous years business tax liability. Therefore half is paid by the 31 January in the year of assessment, the other half by the 31 July in the year following the year of assessment. The third instalment will be any balance due (payable the following 31 January) or any amount repayable by the Inland Revenue if your final liability is lower than the amounts paid on account.

Under self-assessment your income tax return, which encompasses your trading results, needs to be filed by 31 January following the tax assessment year. This date is moved forward to the end of September if you wish the Inland Revenue to calculate your tax liability.

A copy of the Corporation Tax Return (CT600) and an individual’s Tax Return (SA100) is attached.

Starting the Analysis (Back to Top)

One of the most significant factors to be considered in your cash flow forecast is the volume of sales that will be generated in the next several months and for the rest of the period for which you intend to forecast. Your sales forecast must be as fine tuned as possible. It may be unrealistic to assume that there is a million pound market for your product in your area and you will be able to capture a specified percentage of it. A sales forecast needs to be based on specific facts. These might include your sales history or the history of similar businesses you have owned or operated or the competition. In your area, what has been the experience of similar operations?

Some of the questions that should be addressed would include what other factors could I control such as adding new product lines, deleting unprofitable operations, adding a new salesperson, or terminating one that is not producing to quota? In preparing a forecast, you must also take into consideration items such as the seasonality of your business, the relative state of the economy and the period over which you will forecast.

Obviously your ability to forecast sales for the next month is better than it is for three to five years from now. The amount of detail that must be included in the cash forecast is really a matter of preference. It can be based on per unit sales extended out by the sales price of each type of unit or an average sales volume per day, week or month of your type of business in its current environment.

Cash Collections (Back to Top)

Once you have determined a reasonable level of sales and you are comfortable with the forecast you have made, your must address questions such as: what percentage of my sales are received in cash, and what portion are credit sales for which I will have to carry amounts in debtors? For those that are debtors based, how soon is the cash collected? Do I have to wait for customers to pay me or do third parties such as Visa or Mastercard or a debt factor take the customers account and convert it to cash for me with an appropriate discount?

If you are relying on customer payments for collection of debtor balances you must determine what portion of the debts will be collected in thirty days, sixty days, ninety days and thereafter, and what portion, if any, may never be collected. To assume that 100% of your sales will ultimately be converted to cash is probably unrealistic especially considering the current economic environment and the tight cash situations that may face some of your customers.

Other sources of cash may be available in addition to sales. Do you expect to bring in a partner or other investors, or can you borrow money from a bank? When will you receive the cash and how much will you get? Part of your cash flow analysis may be to determine how much investment money or borrowings will be required to operate your business.

Once you are comfortable with the cash receipt side of your business, and the timing of the collections of funds from your sales and other sources, it is necessary to consider the expenses and other cash needs of your business operation.

Disbursements (Back to Top)

Certainly if your business entails sales of stock, you will have to purchase the merchandise from others or purchase the component parts and pay employees to assemble it. This may require a significant outlay of cash before the first pound of sales is generated and received. You should consider how often and in what amount your employees must be paid and when their payroll taxes must be paid over.

Additionally, you need to know the credit trade terms your creditors are willing to advance to you. Do you have to pay for stock items on a C.O.D. basis or can you pay for them thirty or forty-five days after receipt? What expenses must be paid to allow you to convert purchased merchandise to saleable stock? If your production requires utilities to run machines or supplies that are required, such as consumable chemicals or packing materials that must be purchased prior to the sale of the stock, you should consider the timing of these payments.

In addition to the cost of manufacturing, you should consider whether your productive capacity would allow you to generate enough stock to support the level of sales that you are predicting. If the volume of sales you forecast is above your ability to produce today, what changes in your operating environment must be made to meet the production levels. Will you need additional employees, if so, how much will they cost? Do you have to acquire additional machinery for your shop operations? What is the cost of the machinery and when will you have to pay for it? Do you have enough space to cope with the additional activity?

Once you have determined the cost of operating your production or service facilities, you need to consider what other expenses you must pay to keep the doors of your business open. You typically will have to pay rent for your office or manufacturing facility. You must consider how much the monthly payment is and when it has to be paid. Ask yourself if there will be other cash requirements such as a deposit on first and last month’s rent. If you are opening a new business, you must consider what your cash requirements are to make your facility ready for your specific needs and purposes. Will you have to buy or rent furniture? Will you need to make tenant improvements or pay deposits for utilities and other services?

You also need to consider many of the overhead items and costs to open a new business that will hopefully be one-time expenses. This may be a solicitor’s fee for drafting partnership agreements or incorporating your business, the cost to obtain business licences, approval from the taxing authorities, setting up an accounting system, stationery costs, costs of signs or logos.

It may seem like the list of costs and expenses to be incurred is endless. It may even discourage you in moving forward with your business endeavour. However, it is imperative to make the list as detailed as possible to ensure that you have sufficient funds to make your operation ready for business prior to running out of cash. The more detailed the list and the more sufficient information you can provide, the less chance there is of unpleasant surprises as you move down the stream to opening your business.

In addition to determining the amount and volume of expenses and cash outlays you will have to make, it is critical to determine the timing of such payments. As we have discussed in other chapters, there may be a variety of financing alternatives that are available to you. Most of the start-up cost which you incur can be delayed or deferred until you can generate the cash from your operation to help pay them. This needs to be carefully analysed and built in to your cash flow analysis. However, a good rule of thumb is to assume that you are going to have to pay your expenses sooner than you think and that you will collect your cash slower than you anticipate. If you work with this attitude, any surprises should be favourable ones.

Cash flow projections can be very slow, time consuming and tedious to undertake. It is often very tempting to hire someone else to prepare the projections for you. There are a variety of individuals who can help you do this, but the critical factor is that they only help. You as the owner and operator of the business are the only one truly qualified to develop your cash flow projections. You know what it takes to open and operate your business. Certainly a trained professional can offer guidance and ask pointed questions to be sure you are considering all of the necessary and sometimes hidden costs of operating a business. However, the more effort you put into developing the cash flow projections the more accurate they will tend to be. This exercise may also help you to pinpoint areas of potential cash savings that you have not otherwise considered.

We have included a worksheet as an exhibit following this chapter that may assist you in developing a cash flow analysis. Bear in mind however, this worksheet does not include all the items that should be considered in preparing your cash flow analysis but should help raise many of the questions which you need to ask yourself before deciding how much cash will be required to establish and operate your business and what period of time must elapse before you can expect to pay back the lender or return profits to your investors.

The following tax matters require consideration as part of the preparation of your cash flow forecast:

VAT and Other Taxes (Back to Top)

If you are VAT registered (compulsory for businesses with sales in excess of the statutory limit), your sales receipts will include “Output” VAT and some of your costs will include “Input” VAT.

The net receipt of VAT has to be paid over to the Customs and Excise each quarter. If, however, your sales are zero rated, you will be able to claim back the VAT on your purchases.

The basic calculation is not as difficult as is often made out. Typically, adding up your sales receipts for a quarter, multiplying the figure by 17.5 and dividing by 117.5, gives you your output VAT. Do the same for your purchase invoices to calculate input VAT. Deduct input from output and put this figure into your cash forecast in the first month of the next quarter.

PAYE (Back to Top)

If you employ people you will have to deduct tax from their pay and pay it over to the Inland Revenue in the following month. For a forecast it is sufficient to put the gross figure in the cash flow forecast as it automatically includes PAYE.

Self-Employed Income (Back to Top)

If you are the proprietor of a business that is not a limited company, your wages are part of the profit of the company and referred to as “drawings”. The tax that you pay will be based on the profit of the company not the amount that you take out. It is advisable to pay a sum into a deposit account each week to provide for this tax that will be due after your year-end - and it could be a lot of money. Ask your accountant about this!

Many businesses go bust because they fail to provide for the taxes that are payable. Make sure that it does not happen to you!

How Do I Get the Money? (Back to Top)

Irrespective of the type of financing you need and are able to obtain for your business, the process of obtaining it is somewhat similar. There are several questions that must be answered during the course of raising money for your business. The ability to answer these questions is critical to your success in obtaining financing as well as the overall success of the business. Remember, in raising capital you have to sell the ability of your business to potential investors in much the same way as you sell your product to your customers.

1. How much cash do I need?

To answer this question you will have to do some serious cash flow planning, which will require estimates of future sales, the related costs, and how quickly you must pay your suppliers. You will also have to build into your planning some assumptions about when you will generate enough cash to pay the money back. However, if you raise cash through equity you probably don’t need to pay it back but your investors will want to know how the value of the business will grow and how they will benefit through dividends or selling their shares.

2. What will you do with the money?

One of the most important questions you will have to answer for a potential investor is how the money will be spent. Will you use it for equipment or to hire additional employees or perhaps for research and development for a new improved product? Again, part of the answer on how you spend the money is how it will benefit the company.

3. What experience do you have in running your business?

One of the primary reasons for business failure is lack of experience of management. You will need to convince your investors that you have the knowledge, experience and ability to manage your business and their money at the level at which you expect to operate.

4. What is the climate for your type of business and your geographic location?

Few investors will want to put money into your business if you haven’t done sufficient “homework” to determine that you have a reasonable chance of success. If your business is based on existing economic or legal conditions that are subject to change in the near future your risk is substantially increased. Even if your business has great potential, if the local economy is sluggish to the point that it can’t support your venture, you need to be aware of this before moving ahead.

Once you have developed concrete answers to these and other pertinent questions, you can begin looking for financing. One of the first steps is to determine whether to raise funds through debt or share capital. There are positive and negative aspects to each type. The cost to your company of each type of funding is different, as is the way in which they are treated for tax purposes. The interest on borrowed money is deductible by a business for tax purposes, which reduces the effective cost to your company Dividends which you might pay on the same investment in shares would typically not be tax deductible by your company. In selling shares there usually is no firm commitment by your company to pay the money back but your shareholder will want, and generally will have, a legal right to have a voice in the management of your company. When you have made the decision as to the type of financing you think is appropriate to fit your desires and needs, it is probably a good idea to consult with your accountant as to alternative types of debt or equity financing available.

Business Plan (Back to Top)

Typically, a potential lender will want to know all about you and your proposed venture. Many of these details will have already been provided, but are best provided in a logical consolidated format. This format, or business plan, is a document that enables the investor to readily obtain an understanding of your proposal. It follows that in order to successfully raise funding, the business plan should be commercial and realistic.

DNA have experience in writing business plans and can assist you in the effective drafting of your plan.

Financing Alternatives

Whether you determine that debt or equity financing is the best choice for your company, there are a number of alternative types of financing available. Depending upon the nature of your business, the financing may be a combination of debt and equity and may be tailored to fit the specific needs of your company.

In the summary we will only mention a few of the more conventional methods for a young company to obtain capital, though the possibilities are many. DNA can discuss these and other alternatives in greater detail.

Debt Financing Sources (Back to Top)

1. Banks

The first source of funds, which typically comes to mind when borrowing money, is a bank, which is why they are in business. Banks typically lend to small businesses on a secured basis using equipment, stock or debtors. The more liquid and readily saleable the assets you have to offer as security, the more acceptable they are likely to be a banker. Loans from a bank may take several forms such as:

1. An overdraft limit which is reviewed annually and allows you to borrow up to a predetermined maximum as you need it and pay it back as funds from sales and receivables are collected.
2. A short-term loan that is repayable on specified dates.
3. A term loan for the purchase of a specific asset such as a computer or a machine.

As your relationship with your banker become better, and your business becomes established, you may consider a longer (3 to 5 years) loan which will be payable in instalments.

2. Lease Financing

In today’s business environment it is quite common to acquire equipment through lease agreements. Leasing packages come in a variety of types through many sources. Leasing companies typically will accept a somewhat higher degree of credit risk because they are looking to the value of the equipment for collateral if your business cannot make the agreed upon payments. For this reason, leasing companies generally prefer to finance new equipment of a general purpose nature which can be resold if necessary. Leases often run for a period of three to five years and because of the risk that leasing companies are willing to take, they are somewhat more expensive than commercial bank loans.

3. Trade Credit

A very important source of financing for your company may be from the creditors and suppliers with whom you do business. Many suppliers will originally ask for cash on delivery or, in some instances, they want payment before starting on your order, depending on the nature of your purchase. Most suppliers will quickly establish trade credit with you once you have gained their confidence by continuing to do business with them and paying as requested. Establishing good relationships with trade creditors is essential because it allows you to use the goods and services in your operations and sell your product to your customers, in some instance before you pay for them. The trade credit you build today will be relied upon by other suppliers as you attempt to establish yourself with other suppliers in the future. Trade credit terms will vary depending on the type of purchase you make, the industry you are buying from and the industry you are in.

Equity Financing Sources (Back to Top)

Equity financing usually means selling a portion of your business. This can be accomplished in a number of ways including the sales of ordinary or preference shares. Equity sales are usually carefully tailored to meet the needs of both the company and the investor.

Venture Capital Companies (Back to Top)

A venture capital company or fund is typically a company that is in the business of taking risks. A venture capital fund is often backed by a group of investors that may be individuals or companies. The investors are often represented by a management group that evaluates potential investments and manages the existing investment portfolio.

The price of venture capital financing is usually very high when compared to borrowing money from a bank, but it must be remembered that venture capitalists are dealing with much higher risk situations than commercial banks will finance. This cost of venture capital is measured in terms of the portion of your company you must sell to obtain the level of financing you require.
A venture capital firm sometimes requires a 300 to 500 percentage return on its investment over a four to five year investment period. While this may seem like an enormously high return, a venture capitalist is in the risk business and the return on a good investment must help offset those companies that do not meet their projections or fail altogether. To determine the price of such financing, a venture capitalist will start with the amount of financing you require and calculate what he must receive at the time his investment will be sold to allow him to achieve the rate of return he deems necessary.

Based upon the operating projections you provide, discounted based on his experience, he will estimate what your company might be worth at the time his investment will be liquidated. This might be at the point of a public offering or a sale to a corporate investor. The last step for a venture capital company in determining pricing is to calculate what percentage of the company he must own to realise the return he desires. At this point, the “horse trading” generally begins. As a general rule you will want to retain as much of the ownership of the company as you can. The venture capitalist wants enough ownership to achieve his investment goals and have some control over how his money is spent. This will often be achieved by voting power and representation on the Board of Directors at the same time a venture capitalist wants to be sure there is sufficient reward in the company for you and your management team to be motivated and achieve the projections in your business plan.

A venture capital company is often managed by an individual or group of individuals with a strong background in business and management. They can often provide depth of experience and management assistance in areas where your management team may be weak. A venture capital group can very often provide contacts and valuable introductions in your industry. Remember a venture capital investor becomes a member of your team.

Private Individuals

Very often, individuals who are successful in their own right and have accumulated substantial wealth may be looked to for investment in your business venture. Such individuals may believe that the success of your business may enhance theirs as well as help increase their personal wealth. These individuals, like a venture capital company, very often want to participate in the management activities of your firm and help guide your progress through representation on the Board of Directors. The business acumen and contracts of these individuals can often be a valuable asset of your business. An individual investor can often react to opportunity much quicker than a venture capital firm and typically has only his own interests to serve as opposed to a financial backer or group of limited partners.

Individual investors can be more flexible in the type of investment structure they can deal with, and often have personal, financial and tax motivations to consider.

Required Policies (Back to Top)

Very little insurance coverage is mandatory. The only insurance coverage typically required by law is public and employers liability. Your insurance agent can explain the required coverage, the rating systems, and help you purchase a policy. At DNA, we can recommend an insurance broker for you.

You must also be aware that the terms of your building, office lease or mortgage may require you to carry certain kinds of insurance coverage in specified minimum amounts. If you have leased equipment or have borrowed money from a bank or other lenders, there will usually be insurance requirements in the agreements relating to these transactions. There are many other types of policies that you may wish to consider. Specific coverage is provided by each policy and a qualified insurance broker can explain the related costs in depth.

Some of the types of insurance coverage that you might consider for your business are listed below:

Commercial Liability Insurance
There are many types of liability your business may need cover for. "Liability" refers to your legal obligation to pay compensation and costs awarded against you in respect of loss or damage sustained by a third party. Types of liability you may want to consider:

• Public Liability This will protect you from any liabilities from a Third Party (other than your employees) bodily injury or damage to their property that may occur during the normal operation of your business.
• Employers' Liability If you employ anyone outside your immediate family, you are required by law to purchase employer's liability insurance. This insurance offers you protection for any liability arising from injury or illness sustained by employees while they are working for you.
• Product Liability This will protect you from any liabilities from a Third Party bodily injury (other than your employees) or damage to their property that may occur from products you sold or supplied.

Public Liability

Public Liability is used to protect businesses in the event that they are sued by a member of the public. Public liability insurance is set into force to protect you if you are sued by a member of the public claiming that they have suffered a loss as a result of negligence.

Key Man Insurance

Key man insurance allows you to cover key members of your staff or management team, key members whose disability or death could cause harm to your company.
Key man insurance is a type of insurance which few medium and small companies have in place, while many large companies have key man insurance in place but only for directors - i.e. the real key players in the company have not been identified.

Landlord Insurance

If you rent your property to tenants then you will need a specialist landlords' insurance.
As a landlord you face the risk of having to fork out the costs in the event that your property is damaged and you are not insured.

Life Insurance

Life insurance can be a useful policy to have for small business owners who are looking for increased peace of mind over the security of their family and business if they were to die.
Many large companies also offer benefits packages which offer life insurance - the self employed need to be in a position to negotiate their own cover and a life insurance policy should be one of these insurance types.

Product Liability

Product Liability covers you if any products that you sell or provide are faulty of defective.
In the event that you provide a product and it is defective and someone suffers a loss as a result of that product, they are entitled to pursue you for compensation. For example, if you supply a television and it blows up causing damage to someone's property they will be entitled by law to sue you for compensation.

Products, Sales and Servicing Indemnity (PSSI)

Products, Sales and Servicing Indemnity is a packaged cover that is usually provided with employers liability and public liability insurance. PSSI is formed of three different covers:
Products will cover you in the event that you are pursued for selling defective goods.
Sales indemnity has the same purpose as products liability but it kicks into effect with second hand goods and ones which fall outside the manufacturers warranty, it is usually associated with used car dealers
Servicing Indemnity will cover you in the event that you pursued for defective workmanship. For example if you were a car mechanic and forgot to re-attach the breaks properly and the client had an accident as a result of the breaks not working.

Business Interruption (Back to Top)

This coverage, as the name implies, covers the loss of revenues your business would generate if you were forced to shut down for reasons beyond your control. While this is obviously valuable insurance, the policy premium must be carefully considered relative to the potential profits your business might lose during a short shutdown of operations.

Employee Fidelity Bond (Back to Top)

This type of insurance typically covers the risk of loss from theft by employees. If your business deals in large amounts of cash, negotiable securities, or similar types of assets, you may be well advised to consider this coverage. Certain industries are required to carry this insurance by Regulatory Authorities.

Umbrella Coverage (Back to Top)

This type of insurance covers losses above and beyond the limits of other policies that you carry. Umbrella policies usually pertain to liability of various sorts and are usually valuable if your business, or you, has a net worth that requires protection in the event of a catastrophic loss.

Insurance is like any other product that you purchase. Before purchasing it you should consult with more than one broker as to your needs for protection. You should discuss insurance needs with acquaintances in the same or related business as yours. Before buying coverage you should check out the reputation of the company that is underwriting the policy.