Editor's Comment
We have finally reached the end of 2010. It has been a tough year for Ireland Inc. and its citizens. We now have a bailout package agreed with the IMF/EU which should ensure our funding requirements and continuing bank bailouts are adequately financed for the short-medium term. We now know that we have an election looming in the first quarter of 2011. We have had Budget 2011, which was delivered in line with the National Recovery Plan 2011-2014. The Budget tried to strike a balance that would achieve a reduction in the deficit without stifling growth and still encouraging economic activity. This takes out some of the uncertainty that has besieged our country this year. After the election and the approval of the Budget, we should have a more stable economy to allow businesses and individuals to plan with more certainty for the future.
We need more than ever to have confidence to do business, to promote consumer spending and to move back into a positive mindset. We have all had to review our costs and make the hard decisions. It is now time to concentrate on growth and growing our revenue lines.
It is always important to have a good sounding board in business. Good financial advice can never be underestimated, especially from people who understand your business.
In this issue, Dan Holland takes a look at questions you should be asking your finance team to help manage your organisation. Brian Egan reviews Budget 2011 and sets out a selection of the important changes.
Liam Dowdall considers the warning signs of business failure and why a regular operational review could prevent it, and Chris Kenny gives us an overview of the investment markets.
We wish all our readers a very happy Christmas and a successful New Year.
10 QUESTIONS FOR YOUR FINANCE FUNCTION
By Dan Holland
As a business owner, there are some crucial questions that you should be putting to your finance function to assess whether the financial performance of your business is being maximised. This is not an exhaustive list, and different businesses will have different requirements of their finance people, but all companies can benefit from answering these ten questions.
1. Does our finance function understand the business and the aspirations of key stakeholders?
This is key. With the future so uncertain it's important the focus on long-term strategies isn't lost and the key drivers for success, together with associated risks, are understood and monitored closely.
2. Is our finance function helping to drive the business forward?
Many finance functions report on a compliance basis, providing regular historical information to stakeholders. However, the real value of a finance function is to be found looking forward and identifying the opportunities for increasing the financial performance of a business, while minimising risk.
3. Are we getting relevant management information that helps make business decisions?
In the current environment many businesses are using scenario planning to anticipate future needs. More than ever, management accounts with relevant key performance indicators (KPIs) and comparisons to key milestones must be produced on a timely basis with forward looking projections. These need to be flexed according to current trading and various scenarios.
4. Are income streams sufficiently well understood to maximise pricing strategies?
For the vast majority of businesses pricing is fundamental and the finance function should be at the heart of understanding customers' needs, the approach of competitors and the nature of the underlying market so that pricing can be set appropriately to attract sales and provide a sufficient return for the business.
5. Are business risks being minimised?
A strong finance function should assist and direct the business in identifying, documenting and developing plans to control and mitigate the key risks the business faces.
6. Is our working capital requirement being managed?
With order books fluctuating violently in many sectors, the need to turn an order into cash as quickly as possible, and to manage the associated gap, is crucial. Finance functions should always treat working capital and cash management as priorities.
7. Are our relationships with funders strong?
With the current level of uncertainty in the market it is important businesses maintain a strong relationship with their funders, be they banks or equity providers, and ensure they are kept apprised of current and future developments at the company.
8. Is the funding of our business appropriate, and are the related risks being monitored?
Many businesses need flexibility in their borrowing structure but banks are still under pressure to reduce their exposure. Businesses need to understand the risks associated with the different types of borrowing being offered. Invoice discounting may have been appropriate in a buoyant market for a growing business but how will the facility be affected if turnover is reduced or customers extend their payment terms? Different banks have different risk profiles so it is important your finance team finds a lender who will provide the appropriate funding at the right price.
9. Are our business overheads appropriate?
Regular value for money audits and cost benefit analysis of overheads by the finance team will allow a business to negotiate terms with suppliers from a position of strength.
10. Do we get good advice from our professional advisers?
Are you taking full advantage of tax breaks that are available for the business? Are the full implications of investment strategies understood before decisions are made? Similarly, is the business aware of potential changes in financial reporting that may affect the way investors and lenders will look at the business in the future?
BUDGET 2011 - A NEW START
By Brian Egan
Last year, at this time, minister Lenihan predicted that 'the worst is over' and we 'have turned a corner'. In a very confident speech on 7 December 2010, he stated that Budget 2011 provides 'a new start' – most would say it is a pity that we need one. Clearly the corner turned in 2009 led us down the wrong road, a financial cul-desac of some sort.
The worst is coming in 2011 and beyond – in the form of the legislative changes and future policies announced in the Budget. Everything is ending: Charlie McCreevy's generous pension provisioning policies, long-perceived over-generous exemptions from tax on patent royalties, curtailment of artists exemptions, and, probably more widely felt, property tax reliefs. There is an end to or severe curtailment of over 25 tax reliefs/exemptions.
Financial resolutions
The Budget introduces an unprecedented amount of detailed change to our tax system and much of the work, normally reserved for the publication of the Finance Bill in the New Year, has been brought into force either immediately or with effect from 1 January 2011.
This has been achieved through the implementation of some 34 financial resolutions accompanying the Budget. Normally reserved for effecting changes immediately to excise duty on tobacco, these instruments have already been passed through the Dail to amend complex tax legislation.
The changes, as promised, will not leave any taxpayer untouched, and will create some new taxpayers – those who may previously have been exempt or fully sheltered from tax are now brought within the tax net.
Even at the lowest income level, a single person earning just €10,000 per year, will now pay €200 per year in tax instead of nothing, by virtue of the new Universal Social Charge (USC). At the higher end of earnings the reduction in net pay in 2011 as compared to 2010 will be around 5%. The details of tax rate and band changes are contained in our Budget 2011 leaflet*.
Notwithstanding the various changes in the Budget the marginal tax rate is retained at 52% for employees and the self-employed.
The Government spending and social welfare measures are to make up twothirds of the €6bn to be taken out of the economy in 2011, and tax measures just one-third. This commentary is limited to taxation measures.
Review of affairs
It remains our view that the tax system does still provide sufficient flexibility for many income earners to structure their affairs in a manner which can mitigate the effects of this and recent Budgets. For this reason, all such taxpayers should now re-examine the structuring of their business and investment assets. Cautious and sensible actions which may be taken by this group are likely to emerge from such a review.
A selection of the important changes which might impact on such a review include the following.
Pensions
- Reduction in maximum funding levels (€2.3m).
- Increased deemed distributions (3% to 5%) from post-retirement funds held in self administered pension schemes (i.e. more income tax).
- Reduced scope to provide for a pension generally in a tax relieved manner.
For those wishing to maximise 2010 pension provision opportunities, a pension fund payment ought to be made before 31 December 2010 (specific advice should be sought) rather than waiting
Tax-free termination payments
Restriction to €200K of maximum taxfree termination payment on cessation of employment/directorship. Restriction applies from 1 January 2011.
Property incentives
Full abolition of all incentive-type reliefs from 2014 (with some run-off provisions), with immediate severe restrictions from 1 January 2011. Any person with property incentives of any kind where these reliefs have not yet been used should seek detailed advice on these changes, and possibly seek to restructure investment assets as a result. The most disturbing vista for many investors has now been delivered. The nature of the restrictions, which will impact from 1 January 2011, is that individuals who paid expensively to avail themselves of Government-promoted tax reliefs have now been told that the very thing they paid for is to be taken away from them by those who effectively sold it to them in the first place.
Gift/inheritance taxes
- Reduction of tax-free threshold from €415K to €332K in relation to parental gifts to children from 8 December 2010.
- A similar 20% reduction for all other gifts.
- No changes to business property relief, which at least will give some breathing space to those who wish to transfer their business to the next generation. Our advice is to begin this process now where commercially sensible to do so.
Capital gains tax
Surprisingly CGT was not mentioned in the Budget. A case of 'the less said, the better' for the taxpayer. There are still some generous reliefs available in this area. Taxpayers should note, however, that the National Recovery Plan has signalled that rates will rise in 2012, so again it is a case of acting now.
Patent tax exemption
Removed with effect from 24 November 2010. This, along with artists exemption, was seen as overly generous for the times we are in, and few will argue.
Deposit interest
Increase of 2% from 25% to 27% (i.e. 8% increase in the tax liability on this income) for all deposit interest.
Interest relief
No further restriction of interest relief against rental income. However, there was an unexpected change in relief for any person who borrowed to acquire shares in a trading company, with a tapering off of the relief available starting in 2011 and ending in 2013. New loans from 8 December 2010 will not qualify for any relief.
Universal Social Charge
Surely to become known as the USC by all acronym-loving accountants. This replaces the Health and Income Levy and applies on a sliding scale to all taxpayers, reaching a top rate of 7% on income in excess of €16K. The USC will apply on a similar basis as the income levy, i.e. it will apply to income before deductions for many items including pension contributions.
Employee PRSI ceiling
The ceiling for employee PRSI has been removed; this has been threatened for many years and finally the time has come.
The pain of this for higher paid employees (above €75K per annum) has been offset by the USC burden being lower than its predecessor (Income and Health Levy combined).
The road to a healthy economy?
The size of the budgetary adjustment required in 2011 is such that every citizen will be affected by the announced taxation measures. While marginal tax rates have not been increased for employees and indeed have fallen for the self-employed, the reduction in credits and allowances and severe restrictions on pensions and other shelters means that the effective tax rate for many is set to increase substantially.
These measures may be necessary to bridge the fiscal deficit, however, the impact on the general health of the economy will not be known for some time, and indeed reduced levels of take-home pay may – as some economists contend – have a severe depressionary effect on the economy. The minister, on the other hand, would argue that these 'repairs' to the deficit should be viewed as an investment in our future economic well being; in his own words: "A substantial down payment on the journey back to economic health..."
WARNING: DANGER AHEAD? BUSINESS FAILURE
By Liam Dowdall
Is it possible to prevent business failure by looking out for the warning signs, and being more aware of the causes?
Warning signs
Some of the warning signs will be financial indicators. For example, falling turnover, gross margins and gross profit, and cashflow severely haemorrhaging as a result. Other warning signs include a decline in market share, problems with the products or services which may begin to suffer, or perhaps management leaving. Often when a business is in trouble good people will tend to leave while bad people will tend to stay.
As the problems evolve, there will be other, non-financial indicators. You normally observe very low morale in the business. There's no energy or enthusiasm – heads are down. From my experience with turnaround situations you get a good sense of what is going on from talking to people on the ground as much as to senior management, because they have a strong sense of what's going on. Businesses in difficulty tend not to have any clear strategies. Often they'll be like headless chickens, trying everything they can and panicking. People can simply put their heads in the sand to try escape the issues.
Often it's external people, such as the company's advisers or their bankers, who see what's going on before the company itself. Usually, at some stage either the bank or the company's financial advisers tell the company that it needs to address the business issues. The company may try to benchmark its own performance against that of its competitors, but this isn't easy because a lot of the financial information may not be available.
Causes
There's a difference between the symptoms and the causes of a business running into problems. Sometimes the skill is identifying the difference between the two.
There's a great deal of empirical evidence from the 1980s and 1990s (from the US and the UK) which clearly shows that the fundamental reason why businesses decline is bad management. Everything else tends to stem from that.
Internal factors, as already stated, can largely be traced back to poor management. Another common cause of decline is the lack of adequate financial controls – the company doesn't produce accurate or timely financial information, and as a result management cannot identify the warning signs, until in many cases it is far too late.
The main external issues are changes in the market demand and competition. Typically, a business stops producing what customers really want, and doesn't respond appropriately to changes in the market. This feeds into the business not being on the ball in terms of keeping up with the competition.
Invariably 90% of the causes of decline go back to poor management and the management team. Since they are responsible for getting the business into the difficulty, it is logical that changes must be made to the management team in order to get out of the problem. For this reason, there's rarely a successful turnaround that does not involve at least some changes to the management team.
Operational review of a business
From time to time, it's important that business owners take a step back from their business and review the 'state of play'. While there is no reason that this cannot be carried out internally, carrying it out from an independent standpoint ensures that it is a 'warts and all' review.
Although each review will vary in terms of scope and focus, all operational reviews focus on the future strategy to move the business forward. Too often the focus of business reviews can be on cost reduction, and although this is often a factor, it more often forms part of the process rather than a solution on its own. Equally important areas to consider in a business review are:
- potential for shareholder return
- business cultures both within and outside the organisation
- the effectiveness of the management team
- management succession planning
- the effectiveness of financial controls.
Undertaking regular operational reviews of a business should help alert management to any warning signs or causes of possible business failure.
MARKET OUTLOOK
By Chris Kenny
World
Equity market resilience in the face of triangulation of concerns
Markets are currently encountering a triangulation of headwinds. The first concerns US monetary policy. After experiencing fierce criticism post the commencement of QE2, speculation has grown that the Federal Reserve will curtail the bond purchase programme. This is extremely unlikely, and QE2 will continue until the objective of higher core CPI and employment have been achieved.
The second concerns fears that the interest rate tightening cycle in China will produce a hard landing for the economy next year; this has resulted in a 10% correction in the equity market. Again these fears seem overstated. Higher rates are designed to curb excessive speculative credit and not radically change the growth trajectory.
The third headwind emanates from Europe. German insistence that bond holders share the cost of any future sovereign rescue precipitated the collapse in Irish bonds and the subsequent request for an Irish EU/IMF financed bail-out. Contagion fears have reignited with Portugal and Spain seen as the most exposed to solvency pressures. It might well transpire that the ECB have to respond to these pressures by restarting QE. This suggests that the euro, which has fallen by 6% against the dollar, will have more downside.
Europe
German shift triggers turmoil in peripheral bond markets
Sentiment regarding sovereign debt risks ratcheted up substantially in November. The insistence by the German chancellor that private bondholders must expect to share the cost of any future bail-out saw bond holders and corporate deposit holders run for the door. The subsequent surge in bond yields from 6% to 8.9% by mid November forced the Irish Government to accept an IMF/EU rescue package drawing upon the emergency stability fund. The ECB president presciently cautioned that such a move by Germany underestimated the 'reality of the situation' and was adding fuel to the fire.
Concerns rapidly extended from Ireland to other peripheral markets with the spread between German bond yields and those of Portugal, Greece and Spain reverting to levels seen last May.
The principal problem for the peripheral economies remains 'solvency' (the inability to shrink the debt to GDP ratio). With their real effective exchange rates very overvalued relative to Germany we are likely to see more pulses of tension emerge in 2011. While Portugal is seen as the next domino, Spain remains the main focus of attention. In many ways it exhibits similar characteristics to Ireland (high unemployment, and a massive real estate inventory). At the moment the banking sector in Spain looks less vulnerable than Ireland's but we have learnt how quickly perceptions can change. More bank restructuring and recapitalisation in Europe should be expected. Ultimately the way to resolve the crisis would be to establish a fiscal union with a centralised EU treasury function. However, given the shift in German attitude this has de minimis chance of coming to fruition. Hence, concerns over the structure of the euro itself will persist.
UK
Persistent inflation delays the prospect of QE2
The persistence of inflation and the forecast that CPI will remain above the 2% target level until 2012 is proving to be extremely frustrating for the MPC. While IMF analysis shows that the reason UK inflation dynamic has been so different to the US and Europe is mainly due to the pass-through effect of the 20% devaluation of trade weighted sterling over the last three years, any prospect of the UK introducing QE2 has effectively been pushed out into 2011. Mervyn King remains of the view that monetary policy needs to incorporate de facto demand management as the UK faces a combination of fiscal contraction, household deleveraging, weak credit growth and negative real earnings growth.
The labour market in the UK has been remarkably resilient with a total of 167,000 jobs having been created between July and September. However, aggregate earnings growth has been hampered by all the job creation coming entirely from part time vacancies. This is helping to subdue inflation expectations.
The UK Government's pledge of £7bn to the Irish Government is justified by the fact that UK banks, principally Lloyds and RBS, have significant loan exposure to Ireland. Ireland is also an important export market.
The equity market is consolidating after the strong rally between September and November. Given the recent turmoil in Europe it has shown remarkable resilience. With liquidity remaining supportive, any sign of positive earnings revisions should act as a catalyst for another upward move.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
