What you should consider when investing in a business

Investing in a business is a daunting decision. Whether you are investing in a new or established enterprise, there will always be risk involved. The best way to mitigate these risks is to gather as much information as possible on the enterprise you wish to invest in.

But how do you go about gathering this valuable information?

  1. Basic knowledge of the entity will be gathered at the beginning, through a general description of the entity and industry it operates in.

During the basic evaluation, you should determine if the entity is trading in an industry that you wish to align yourself with, whether you have experience with the product or service provided and the current economic environment.

  1. An informal sit-down should be organised, a meet-and-greet if you will. It is generally expected to enter into a non-disclosure agreement with the entity before any sensitive information is shared.

At this point, it is good practice to appoint an independent advisor that can assist with the negotiations and even act as a mediator to ensure that all parties are heard. This way the parties become familiar with one another and you gain insight into the basic operations and management of the entity.

  1. Should you proceed, a due diligence of the entity should be considered.

During the due diligence, a detailed evaluation of the company’s records will have to be performed.

Since there is a vast amount of documentation to consider, some of the core information that should be requested and considered is:

  • Financial statements for the previous 3 to 5 years;
  • Management accounts to date;
  • Dividend history;
  • Forecast of profits, investments and planned asset purchases; and
  • A tax clearance certificate.

Through the above information, you will be able to determine the profitability and growth opportunity of the entity.

  1. Should you like what you see after a due diligence has been performed, a formal sit-down should be arranged between parties to negotiate the terms of the investment.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted. (E&OE)

Managerial accounting: The key to better business

As a manager of an organisation, there is a great responsibility for decision making. The question lies in how a manager can utilise accounting information to make better decisions. Managerial accounting is a common practice within an organisation where accounting information is identified, measured, analysed, interpreted and communicated to relevant parties to pursue a goal.

Accounting information can be analysed in different ways and be used for different purposes. It’s important to identify the type of decision that needs to be made to ensure that the correct accounting information is gathered and analysed for the best decision making.

For instance, an organisation that wants to attract investors will depend mostly on cash flow statements and cash flow forecasts, the income statement and a balance sheet, whereas an organisation that needs to apply for a loan will rather look into certain ratios such as debt to equity and debt to service coverage ratios.

Managerial accounting is mostly used in scenarios where quick decisions need to be made to help managers optimise business operations. Accounting information is used by managers to plan, evaluate the company performance and manage risks. Budgeting is a great part of an organisation and financial reporting can help a manager to set a realistic budget and identify the need for funding. To measure the company’s performance certain ratios can be used such as the liquidity ratio which measures the company’s ability to generate cash to meet the short-term financial commitments, efficiency ratio that mostly relates to the inventory turnover and the profitability ratio can be used to measure the return on assets and net profit margins.

The first step to making an informed decision is to have information that is reliable and up to date, thereafter the accounting information can be utilised in different ways to ultimately form a report that would help management to make better decisions.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted. (E&OE)

What should you consider when investing in a business

You have worked hard for many years, and have finally saved enough funds and mustered the courage to take the big leap that you have been dreaming about for such a long time… you are going to invest in your own business.
 
You have found the perfect business and is excited about your new journey, when you suddenly realise, however, that you have never been in this situation, and suddenly have no idea what to do next.
 
The first step
 
It is important to understand what you wish to gain out of your investment. Some people may solely invest in a business for financial gain, while for others it may be fulfilling a life-long dream, or to chase a very specific passion, such as having the opportunity to jump out of an airplane every single day through your newly acquired skydiving school, for instance.
 
Although motivation will differ for each person and will likely include a number of factors, it is important to understand what drives your decisions, in order to invest smartly.
 
Start with the end in mind
 
Once you understand the why behind your investment decision, it is a good principle to start with the end in mind. Ask yourself where do I want to be in the next three to five years (skydiving every day, the richest person in my street, having loads of free time, etc.) and how you will be able to leverage your business to get you there.
 
Good questions to ask might include –

  1. Is the business scalable (the ability to multiply a business model);
  2. Is the business labour / time intensive;
  3. Do you have adequate and necessary skills to manage the business;
  4. Are you aware of all the risks that you are assuming through investment;
  5. Is the price that you are willing to pay for the business substantiated and reasonable;
  6. Etc;
Practical considerations
 
In practical terms, there are a number of ways in which to invest in a business, primarily including acquisition of a going concern, as opposed to equity / members interest in an existing entity. It is also important to understand the advantages / disadvantages of the structure in which you choose to invest. You might decide to invest as a sole proprietor, through a company, a corporate structure or a trust (etc.) for instance.
 
The above considerations can have a major influence on a variety of factors, including statutory risk, tax consequences, contracting procedures, etc. and if the process is not approached correctly, it can cause many unnecessary headaches in the long-run.
 
Summary
 
Investing in a business, is no doubt always a very exciting prospect which, if approached correctly, can have a profoundly positive impact on a person’s life. It can be a precarious process, however, if not negotiated carefully.
 
It is therefore recommended to find a credible and experienced partner, to help guide you through the process, and even to further strategically aid and assist you post the investment.
 
This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted. (E&OE)

Management’s responsibility

Throughout the audit of a set of financial statements, the phrase “management/director’s responsibility” appears. It is included in the engagement letter, the financial statements and the auditor’s report.  But what does it mean?

Management is responsible for the management of the business, for implementing and monitoring of internal controls in the business, and in terms of the Companies Act (“the Act”), for maintaining adequate accounting records and the content and integrity of the financial statements.  These financial statements must be issued annually to reflect the results thereof.

These financial statements are used by various users (shareholders, directors, banks, SARS, etc.) to make certain decisions (buying and selling of shares, valuations, credit terms, etc.), and therefore need to be a true representation of the business.  It is therefore critical that all transactions are valid, are recorded accurately and completely in the correct financial year, are classified correctly, and that all assets and liabilities that exist are recorded at the true cost/value thereof.

In terms of the Act, financial statements are to be prepared using either International Financial Reporting Standards (“IFRS”) or IFRS for Small to Medium-sized Entities (“IFRS for SME’s”).  Luckily management is not responsible to be experts in the above-mentioned standards, as the Act does allow for management to delegate the task of preparing the financial statements to someone with the knowledge and skill set to be able to perform this task.  The Act does, however, not allow management to delegate the responsibilities that go along with it too, so they need to ensure that when they do delegate the task, that it is to a responsible person and that they review the financial statements before approving it.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Short term insurance: Consequences of being over or underinsured

Some people believe in short term insurance, others don’t. If you do believe in taking out short term insurance, make sure that your assets are not over or underinsured. If your assets are overinsured, it means you pay unnecessary premiums for insurance cover you will not be able to claim for. If you are underinsured, you think you are covered for a certain amount while in actual fact you are not covered as well as you think you are.

Overinsurance

Let’s look at Mary’s case:

Ten years ago, Mary bought and insured her car at its then market value of R50 000. Although the market value of her car decreased over time, she never informed her insurance company.

Yesterday she had an accident and wrote off her car. She puts in a claim at her insurance company for R50 000 because that’s the amount her car was insured for.

As the car was insured at market value, the insurance payout is based on the current market value of the car. At the time of the accident, the car’s market value was only R10 000.

Mary is very unhappy because she paid premiums on a market value of R50 000 and now she only received R10 000 from the insurance company.

What happened here?

Mary was overinsured because her car was insured for more than its market value. It was her responsibility to contact her insurance company from time to time to adjust the insured value of her car downwards as its market value had decreased over the years. As the car’s insurance premium was based on its market value, her premium would have reduced every time she informed her insurance company to adjust the market value of her car downwards, and she wouldn’t have paid for more than the amount she was insured for.

Underinsurance

Now let’s look at John’s case:

He originally bought his house for R50 000 and insured it at its then market value of R50 000. Ten years later disaster struck and the house burnt down. At the time of the fire, the house is worth R100 000. However, John never let the insurance company know that the market value of his house increased over the years.

John puts in a claim at his insurance company for R100 000 but the insurance company pays out only R25 000 to settle his claim of R100 000.

What happened here?

The insurance company calculated the ratio between the value John insured his house for and what it was worth at the time it burnt down as follows:

Value insured / Current market value = R50 000/R100 000 = 50%

The ratio of 50% means that the house was insured for only half of its market value of R100 000 at the time of the fire.

Then the insurance company applied the pro rata ratio of 50% to the amount actually insured to calculate the amount of the insurance payout as follows:

Amount insured x Ratio underinsured = R50 000 x 50% = R25 000

If John contacted his insurer from time to time to increase the insured amount of the house to the actual market value, the insurance cover on his house would have been in line with its actual market value of R100 000 when his house burnt down. His premiums would have increased over time to reflect the increase in the insured amount.

Both the above scenarios illustrate the same point: it is crucial that your insurance company have accurate and up to date information on which to determine the amount of your insurance cover and premiums. Ultimately it is your responsibility to keep an eye on the market value of your assets and inform your insurer of any changes in market value that would require an adjustment in the insured value of an asset.

This article is a general information sheet and should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Reference List:

Accessed on 18 September 2015

  • SAIA Consumer Education Booklet written by Denis Beckitt

The obligation to provide access to certain information about your business

The Promotion of Access to Information Act (PAIA), No 2 of 2000, was enacted in an effort to foster a culture of transparency and accountability in the public and private sector. It gives effect to the constitutional right of access to any information held by the State or any other person and  that is required for the exercise or protection of any rights of any person.

This implies that any person whose rights may be affected may request any of the prescribed information as defined in the Act from a public or private body by following the applicable procedures. The public or private body is then legally compelled to provide such information in the prescribed manner.

Section 51 of this Act requires the head of a private body to compile, within six months after the commencement of this section of the Act or within six months after the establishment of the private body, a manual containing certain prescribed information, such as:

  • postal and street address, phone and fax numbers and email address of the private body
  • the latest notice regarding the categories of records of the private body which are available without a person having to request access in terms of the Act
  • a description of available records generated by the private body, indicating which records are automatically available and which records are available on request
  • the request procedure to be followed in terms of the Act, as well as the applicable fees
  • a statement confirming the head of the public body
  • other information as prescribed by the Act

This manual should be updated every time a change in the prescribed information occurs and must be:

  • submitted to the Human Rights Commission
  • submitted to the controlling body of which the private body is a member (if applicable)
  • published on the privatebody’swebsite (if applicable)

A private body is defined as:

(a) a natural person who carries on any trade or business or profession
(b) a  partnership that carries on any trade or business or profession
(c) any former or existing juristic person, but excluding a public body

When a person requests information in terms of this Act, it must be provided if:

a) the information is requested to exercise or protect a right
b) the person follows the correct procedure as prescribed by the Act
c) access to that information cannot be denied on any of the grounds of refusal as stated in the Act

The deadline for the submission and publication of the PAIA Manual for public and private bodies was 31 December 2011. However, for certain private bodies in certain economic sectors, this has been extended until 31 December 2015.  These exceptions are based on:

  • the economic sector in which the private body operates its business
  • the total number of employees being less than 50
  • the turnover of the private body being less than a certain amount per economic sector

This extension does  not otherwise impact on the enforcement of this Act, and the rest of the requirements of the Act are currently enforced.

The penalty for non-compliance is two years imprisonment or the possible option of fines.

This article is a general information sheet and should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.