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Cape Town - In an effort to keep taxable earnings down, many business owners will run personal expenses through their business.
Travel, cars, dining out and sports club memberships may be legitimate deductions in some instances, but many business owners simply go overboard, Gary Palmer, CEO at Paragon Lending Solutions.
This behaviour can lead to challenges should the owner want to exit, or raise capital to expand.
Some business owners believe putting as many personal expenses through the business will lower taxable income. However, it is a double edged sword, says Palmer.
"Should you wish to source financing, traditional lenders will look at your financials and, in all likelihood, your spending will prejudice your ability to raise money. Lenders will examine the company’s ability to service the loan. If the business is funding the lifestyle of the owner, the numbers will simply not stack up and the loan will not be granted," says Palmer.
"Many a business owner has also been caught on the back foot when it comes to retirement. Since, so much of their personal expenses have been taken care of by the business, they underestimate their financial requirements and find themselves having to significantly downgrade their lifestyle."
READ: Small business, big money
Selling
This is also the case when owners try to exit the business by selling it.
"We have seen businesses reporting millions in turnover, but only showing a few thousand rand in profits," says Palmer.
"While it is common (and legal) for directors to take out loans from the business, if the loan account is on the books for more than a year, it will become taxable on their personal tax. What’s more penalties will also be applied."
Business owners who are looking to finance growth should begin preparing their company to approach financiers. Take a long, hard look at just how the company is spending its income. If necessary, they should strip out any personal loans or expenses going to the owner and directors.
"If they know there is growth opportunity on the horizon, they should also consider approaching lenders in the short-term. Having a critical eye run over the balance sheet will help identify potential pitfalls," says Palmer.
"As we enter a tighter economic cycle, far too many companies go into survival mode. There is always plenty of opportunity in the market, and there is still money available to fund great deals. The trick is to ensure that your business is 'financing fit' at any given stage - even if this means sacrificing some short-term lifestyle luxuries."
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