Understanding Business Accounting For Dummies, 2nd Edition (127 page)

Invoice discounting is a variation on the same theme. Factors collect in
money owed by their clients' customers, take a fee, and pass the balance on, whereas invoice discounters leave their clients to collect the money themselves. This could be an advantage for firms that fear the factoring method might reduce their contact with clients. Invoice discounting is, in any case, typically available only to businesses with a turnover in excess of £1 million.

You can find an invoice discounter or factoring business through the Asset Based Finance Association's directory at
www.thefda.org.uk//files/03/92/78/f039278/public/membersList.asp
. InFactor (
www.infactor.co.uk
), launched in April 2006, is an online service for comparing factoring.

Grants and Incentives

Surprisingly, there really is such a thing as a free lunch in the money world. These free lunches come from benevolent governments whose agenda is either to get businesses to locate in an area bereft of business but jammed full of people looking for work, or to pioneer new, unproven, and risky technologies. Absolutely no evidence exists that governments get any value out of this generosity, but that's the thing with governments - they feel they have to
govern
, and people are more prepared to listen to others that have open wallets.

Grants are constantly being introduced (and withdrawn), but no system exists to let you know automatically. You have to keep yourself informed. The Business Link Web site (go to
www.businesslink.gov.uk
and click on ‘Finance and grants' and ‘Grants and government support') has advice on how to apply for a grant as well as a directory of grants on offer. The Microsoft Small Business Centre (
www.microsoft.com/uk/businesscentral/euga/home.aspx
) has a European Union Grant Advisor with a search facility to help you find which of the 6,000 grants on offer might suit your business needs.
www.grants.gov
is a guide to how to apply for over 1,000 federal government grants in the US.

Governments aren't the only guys with open wallets. More than a thousand annual awards around the world aimed at businesses exist. They are awarded for such achievements as being the greenest, cleanest, fastest (growing, that is), best company to work for, and a thousand other plausible superlatives to make you feel good. The guys giving these awards are in it for the publicity, and heck, if you can get your hands on some free money, swallow your pride and head on down. Business plans are central to most of these competitions, which are sponsored by banks, the major accountancy bodies, chambers of commerce, local or national newspapers, business magazines, and the trade press. Government departments may also have their own competitions as a means of promoting their initiatives for exporting, innovation, job creation, and so forth. You can find a Business Plan Competition Directory on the Small Business Notes Web site at
www.smallbusinessnotes.com/planning/competitions.html
, but for the rest, you'll have to keep your ear to the ground and tap into the grapevine.

Using the Pension Fund

In 2001, a landmark ruling in the House of Lords allowed the UK power supply industry to stick like glue to £1bn in surplus pension contributions. The surplus arose from the better-than-expected performance of the industry's investments to that date, and the ruling gave companies the green light to begin ‘raiding' pension funds. The companies had used surpluses for redundancy payments and to finance the pension holidays that allow companies to suspend contributions - all strategies that diverted some of the pension pot to other investments in the business. Changes to pensions regulations since 2003 have made taking contribution holidays harder, unless schemes show a healthy surplus. Watch this space, though, because the largest 200 UK company pension funds showed a total surplus of £5bn at the end of September 2007.

This financing strategy is mostly available to private companies with a relatively limited number of participants - usually directors, partners, top managers, and shareholders. In these cases, the company can pay money out of business profits, thus escaping tax, into either a Small Self-Administered Scheme (SSAS) or a Self-Invested Personal Pension Plan (SIPP). That scheme can then invest in a narrow range of asset classes such as the company's own shares, purchase of commercial property, and loans to the company, subject to certain conditions and with the approval of the pension trustees. The trustees are themselves regulated by the Pensions Regulator (
www.thepensionsregulator.gov.uk
). The aim of any pension investment must be to enhance the value of the pension fund for the ultimate benefit of all the pensioners equally.

The fun doesn't stop at being able to use pensioners' money to invest in the business they work in. Both SSAS and SIPP schemes can (since April 2006) borrow up to 50 per cent of their net assets to purchase property. So, if an SSAS/SIPP has total assets of £100,000, it can borrow a further £50,000, thus providing up to £150,000 to invest in qualifying business assets.

You can get the lowdown on SSAS and SIPP pension schemes from companies such as Westerby Trustee Service (
www.sipp-ssas-pensions.co.uk
) and Clear Financial Solutions (go to
www.clearfinancialsolutions.co.uk
and click on ‘Business Solutions' and ‘SSAS/SIPP').

Chapter 18
:
Ten (Plus One) Questions Investors Should Ask When Reading a Financial Report

In This Chapter

Analysing sales and profit performance

Investigating changes in assets and liabilities

Looking for signs of financial distress

Examining asset utilisation and return on capital investment

Y
ou have only so much time to search for the most important signals in a business's financial report. For a quick read through a financial report - one that allows you to decode the critical signals in the financial statements - you need a checklist of key questions to ask.

Before you read a business's annual financial report, get up to speed on which products and services the business sells and learn about the history of the business and any current problems it's facing. One place to find much of this information is the company's annual accounts filed at Companies House, which is a public document available to everyone. (You can also usually find this information on the company's Web site, in the investor affairs section.) Company profiles are prepared by securities brokers and investment advisers, and they're very useful.
The Economist
,
Investors Chronicle
, and other national newspapers, such as
The Financial Times
, are good sources of information about public companies.

Did Sales Grow?

Ron, that friend of ours who owns a flower business in Devon and whom we quote in Chapter 16, hit the nail on the head: He said that a business makes profit by making sales (although you do have to take controlling expenses into account). Sales growth is the key to long-run sustained profit growth. Even if profit is up, investors get worried when sales revenue is flat.

Start reading a financial report by comparing this year's sales revenue with last year's, and with all prior years included in the financial report. A company's sales trend is the most important factor affecting its profit trend. We dare you to find a business that has had a steady downward sales trend line but a steady upward profit line - you'd be looking for a long time.

Did the Profit Ratios Hold?

Higher sales from one year to the next don't necessarily mean higher profit. You also need to look at whether the business was able to maintain its profit ratio at the higher sales level. Recall that the
profit ratio
is net income divided by sales revenue. If the business earned, say, a 6 per cent profit ratio last year, did it maintain or perhaps improve this ratio on its higher sales revenue this year?

Also compare the company's
gross margin ratios
from year to year. Cost-of-goods-sold expense is reported by companies that sell products. Recall that gross margin equals sales revenue less cost of goods sold. Any significant slippage in a company's gross margin ratio (gross margin divided by sales revenue) is a very serious matter. Suppose that a company gives up two or three points (one point = 1 per cent) of its gross margin ratio. How can it make up for this loss? Decreasing its other operating expenses isn't easy or very practical - unless the business has allowed its operating expenses to become bloated.

In most external financial reports, profit ratios are
not
discussed openly and frankly, especially when things have not gone well for the business. You usually have to go digging for these important ratios and use your calculator. Articles in the financial press on the most recent earnings of public corporations focus on gross margin and profit ratios - for good reason. We always keep an eye on profit as a percentage of sales revenue, even though we have to calculate this key ratio for most businesses. We wish that all businesses would provide this ratio.

Were There Any Unusual or Extraordinary Gains or Losses?

Every now and then, a business records an
unusual
or
extraordinary
gain or loss. The first section of the profit and loss account reports sales revenue and the expenses of making the sales and operating the business. Also, interest and income tax expenses are deducted. Be careful: The profit down to this point may
not
be the final bottom line. The profit down to this point is from the business's ongoing, normal operations before any unusual, one-time gains or losses are recorded. The next layer of the profit and loss account reports these extraordinary, non-recurring gains or losses that the business recorded during the period.

These gains or losses are called extraordinary because they do not recur - or at least should not recur, although some companies report these gains and losses on a regular basis. These gains and losses are caused by a
discontinuity
in the business - such as a major organisational restructuring involving a reduction in the workforce and paying substantial severance packages to laid-off employees, selling off major assets and product lines of the business, retiring a huge amount of debt at a big gain or loss, and settling a huge lawsuit against the business. Generally, the gain or loss is reported on one line net of the corporation tax effect for each extraordinary item, and a brief explanation can be found in the footnotes to the financial statements.

Investors have to watch the pattern of these items over the years. An extraordinary gain or loss now and then is a normal part of doing business and is nothing to be alarmed about. However, a business that reports one or two of these gains or losses every year or every other year is suspect. These gains or losses may be evidence of past turmoil and future turbulence. We classify these businesses as high-risk investments - because you don't know what to expect in the future.

In any case, we advise you to consider whether an unusual loss is the cumulative result of inadequate accounting for expenses in previous years. A large legal settlement, for example, may be due to the business refusing to admit that it is selling unsafe products year after year; its liability finally catches up with it.