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Directors, it's time to take your business out of the financial wilderness I'm sure you will agree it hasn't been a great 5 years for finance companies and their directors. The level of duty required by directors has been tested in recent court cases on both sides of the Tasman. The New Zealand cases of Feltex Carpets and Nathans Finance, together with the Healey (Centro) case in Australia, have helped put the spotlight on the role and responsibilities of directors – particularly in respect of reviewing and approving a company's financial statements (and offer documents). While the above court cases centre on high profile companies, they do hold valuable lessons for all businesses, big or small. • • Although directors can rely on expert advice, they cannot abdicate their own fundamental responsibility to review and approve a company's financial statements. You know your numbers... Directors must have sufficient knowledge of conventional accounting practices and must apply that knowledge based on information they have received as directors. Let's start at the top. Sections 131 to 138 of the Companies Act 1993 outline the key responsibilities of a director. Whilst I'm not going to list these down, it is a good idea to familiarise yourself with them. You may want to also skim your eyes over sections 373 to 386F - dealing with offences and penalties! "So how does this apply to me?" I hear you ask. As a director you have a responsibility to everyone that relies on your company's financial statements. Therefore it is also your responsibility to fully understand what your financial statements mean and thus ensure the best possible return on investment for everyone. There are many New Zealanders out there who have come up with fantastic ideas and who have the courage and conviction to go out on their own and test the market. However, these same rising stars often dread handing over their financials to their accountant at the end of the year and discovering how much money is in their bank account. So here is a useful tool to help take away some of the mystery surrounding your financial statements… The Financial Operating Cycle Below is a visual representation of your financial statements: Your Profit and Loss (or Statement of Financial Performance) is a cumulative picture of the business over a period of time (typically one year). In other words, it shows your income less expenses to give you your net trading result. The key factors which can impact your Profit and Loss are pricing, margin maintenance and expense control. An analysis of your gross profit (sales less direct costs) and your net profit (gross profit less overheads) will provide you with key data to help run your business more efficiently. Your Balance Sheet (or Statement of Financial Position) represents the most important information to a director as it provides a summary of the financial health of your business. Simply put, it shows how the Assets of the business are funded – either through external borrowings (Liabilities) or through owners' equity (Retained Earnings). It can help answer important questions such as "Can you meet your debt repayments on time?" "Where have you spent your profits?" Retained Earnings are essentially the link between the two statements. Despite what you may have heard, when it comes to your profits, there are really just three fundamental uses for them: 1) Invest in new assets (new equipment, technology, stock etc) 2) Repay your debts (bank, hire purchase, family funds) 3) Distribute it amongst the business owners i.e. pay-out dividends. but do you know their meaning? Keeping your business future fit is about being better equipped to make bold and powerful financial decisions. At Hayes Knight, rather than just work the numbers, we interpret them. The result is a more empowered, knowledgeable client able to be proactive with the next steps of their business. To find out more, visit hayesknight.co.nz Amanda Billington Business Services Manager Hayes Knight NZ Limited 09 414 5444 www.hayesknight.co.nz www.twitter.com/hayesknightnz PROFIT & LOSS Sales Net Profit Uses of Profits 1. To pay for new assets 2. To pay off debt 3. To pay out to the owners The Financial Operating Cycle BALANCE SHEET Assets = Liabilities + Net Worth EFFICIENCY Back to: Assets Liabilities Net Worth For the long-term viability of any company, the business must supply suitable profits to satisfy all three requirements. A note of warning – don't get retained earnings confused with cash! As many a growing business will tell you – profits generally do not equal cash (but that is a whole new article). In short, to fully understand your financial position you need look at both your Profit and Loss and your Balance Sheet – one is relatively useless without the other. As directors, you owe it to yourself (and your business) to understand your financial statements and to question until you do!