The World Bank estimates that New Zealand’s cash economy is worth around $20 billion, and this is costing the New Zealand Government around $1 billion each year in lost tax revenue. If you’re part of this cash economy and plan to one day sell your business, what you may not realise is that you’re stealing from yourself every time you make an inaccurate report to the IRD. Operating in the cash economy can lower the value of your business and even lessen the chance that it’s sold at all.
Unreported Profits
One of the most important figures when it comes to selling your business is your profit. The starting point for most valuations is your reported profit times a multiplier, often a standard figure based on the industry. Maximising your reported profit is a key way to receive a larger offer at sale time.
However, if you can’t prove that you made the profit, it can’t be included in the valuations. Although you may think that not reporting that cash-in-hand job to the tax man is keeping a little extra money in your pocket, it can cost you significantly more than you saved.
For example, if you have $25,000 in unreported income, this will have saved you around 30 percent in taxes, or $7,500. But if your business value is your profit times four, that’s $100,000 that won’t be offered to you by the buyer.
Potential buyers will not take your word that there’s an extra $25,000 profit available for them under the table. They want to see proof, and if you’re not reporting these profits, you’re not able to offer proof.
Unreported Expenses
If you’re using unreported income to pay for your expenses, you may also have inaccurate financial records. Similarly, businesses that pay suppliers or staff under the table, probably have inaccurate expense sheets.
During due diligence, prospective buyers will ask to see detailed expense records, and any inconsistencies will be a red flag for potential buyers. For example, if you run a carpentry business but there’s no wood listed in your expenses, it will definitely raise questions.
If your records don’t appear to include all business costs, the prospective buyer will likely adjust their offer down to account for expenses that aren’t listed. Without proof from you of the regular costs, the buyer is also likely to overestimate, leading to a lower purchase cost for them. And that’s the good scenario; in some cases, a buyer will withdraw their offer because they no longer trust the accuracy of other figures and financial records.
Increased Risk for the Buyer
Any prospective buyer of your business wants a good profit with minimal risk, and a business that hasn’t been reporting its income properly is a risk. The IRD is continuing to look closely at businesses in certain industries in an attempt to collect some of that $1 billion of lost revenue. Even a business in an industry that’s not traditionally cash-based can be caught if your income and expenditure don’t seem to match up.
Potential buyers understand the implications of undeclared income. No one wants to buy themselves more stress, and a cash-in-hand business could bring the stress of a bad audit, a large tax bill and potentially large fines. Most buyers will walk away from a sale rather than buy that sort of risk.
If you’re planning to ever sell your business, not declaring your income is one of the worst mistakes you can make. Rather than helping you save money by not paying tax, it could lead to an offer which is thousands of dollars lower than it could be. In the worst-case scenario, it could stop you from being able to sell at all. Declaring all your profits to the IRD allows you to base your business’s value on all your profits and is one of the simplest ways of increasing the valuation when it’s time to sell.
For further information, contact your nearest LINK Business Broking Office.
