Take time to sit back, think, get advice

AMANDA MORRALL

Running a small business can be all consuming, leaving little time for anything but the immediate issues. In our latest Money Makeover AMANDA MORRALL sifts through one couple's to-do list.

Jane and Paul, both in their 40s, run a successful small business in Christchurch. They have two children; one in university, another who goes to private school.

Between work and family life, the couple are flat-out. Both play an active role in their business, putting in more than 80 hours per week combined. Business is good, despite the downturn, and plans are underway for an expansion.

While the bank account has been building up over the years, the couple feel their finances suffer from lack of attention, time and structure.

They are debt-free and own a home worth about $450,000. Their business has an estimated value of $275,000 and they have about $138,000 cash in the operation.

Personally, they have combined assets worth $206,000; $91,000 in cash, $105,000 in shares listed on the NZX and $10,000 in corporate bonds. They have some art work of reasonable value and a potential inheritance down the road.

Excluding the working capital they need for the business, they have total assets available to invest of $274,000. With no formal savings strategy, and no long-term financial plan, the couple worry about their financial future.

"We've always floundered a bit and while we've had reasonable income and been self-employed for as long as we have, we've never had any financial plan," Paul says.

While they are in a position to start investing more strategically, Jane says they have hesitated because of the economic downturn and steep declines in stockmarket performance. Negative press about the financial sector has also held them back from seeking out an adviser, they say.

For an expert opinion, MoneyMakeover consulted James Smith, a financial planner with Bradley Nuttall in Christchurch.

Based on their existing investible assets of $274,000, Smith informs the couple that their long-term financial security is more or less assured.

Their nest egg, plus annual contributions to KiwiSaver of $4000 a year until age 65 - earning 3 per cent per year after tax, fees and inflation - would allow them to retire at that time with an annual spending allowance of between $50,000 and $60,000.

The projection assumes they would both qualify for and receive the New Zealand Superannuation at age 65, which works out to roughly $24,000 (after tax) for the couple.

With Australia having changed the age of eligibility for its Superannuation to 67 (to take effect in a decade), there is speculation that could happen in New Zealand at some point. It is also possible super could end up being means or asset tested, adds Smith.

He tells Jane and Paul they have a "debt to equity" ratio of 60/40 with 60 per cent of their wealth in defensive assets (cash) and 40 per cent in growth (shares).

Debt refers to cash, term deposits and fixed-interest securities, where you are effectively 'loaning money' to a financial institution, in return for agreed payments of interest and principle. Equity is investments like shares or a property where the investor, becomes a stakeholder or owner.

"In this relationship you may get some income [from dividends or rent] plus some capital growth but overall your capital is more at risk because you are sharing in the general profits or loss of the business entity.

"However, because of the extra uncertainty of returns, the earnings rate is normally higher over the longer term. Risk and return are related.

The higher the risk, then usually the higher the expected return."

Jane and Paul's current debt to equity situation would seem to be the most appropriate for their objectives, Smith notes.

However, maintaining the same overall ratio, Smith says they could still enhance their returns by transferring more cash into "high-grade, fixed- interest securities".

That's because the interest they are earning on their cash is about 4 per cent whereas good quality fixed-interest securities are currently yielding a 7-8 per cent return.

All of Jane and Paul's shares are in New Zealand companies.

By investing in a broader range of asset classes - for example Australian and international shares and listed property trusts - they would lower their risk through greater diversification and boost their returns, Smith says.

Jane and Paul's risk profiles suggests they could invest 60-70 per cent of their money in "growth" assets - investments like shares that chase higher returns. Smith says risk plays a crucial factor in the construction of an investment portfolio and a robust discussion is paramount.

"It is healthy for a client to have a good amount of input into this so they have an appreciation of the risk/reward trade-off. After all, they will experience the results."

According to their risk profiles, Paul and Jane would still be able to sleep at night with a higher risk strategy, but they are still likely to achieve their objectives with a lower risk strategy.

Smith says taking unnecessary risk would be pointless under the circumstances. As for the business, which currently operates as a partnership, Smith suggests running it as a limited liability company, through a trust, could be more profitable from a tax perspective.

As a partnership, they are being taxed at the top rate of 38 per cent. If they had a company structure, Smith says the trust could own the shares, and their salaries could be taxed at a maximum rate of 33 per cent.

If distributions were made to non- minor beneficiaries (age 16 and older) the tax rate would be even lower.

That would enable the couple to pay their son's tuition through a distribution made by the trust, effectively saving them $2500 in tax.

Smith recommends they get an accountant to do a detailed cost-benefit analysis to determine what business structure would be most beneficial tax wise.

In terms of their involvement in the business, which the couple complains has limited their ability to do more long-term planning, Smith proposes they look into ways of weaning themselves from it.

"For many SMEs [small and medium enterprises] it can be difficult to get away from the business; the business can start running their lives, rather than the other way around."

As owners, the challenge is maintaining customer loyalty without always being behind the counter, Jane and Paul point out.

Smith says it is a well- recognised dilemma for many SMEs. He says business advisers often recommend owners work on systems and processes to train staff so that businesses can operate just as well without them.

As the couple have discussed the possibility of a potential sale in a few years, Smith says it would be wise for them to develop such a "how to" manual - not only to free up more time but also to groom the business for sale.

Overall, Smith says the couple is in good financial form having worked hard and enjoyed some good fortune along the way.

But given their time constraints, running a business and raising a busy family, he suggests they would benefit from a plan at this point in their lives and some professional advice.

"Modern life is busy and sometimes cluttered, this cluttering takes away our focus from things that are important and we become reactionary to events. De-cluttering gives us that focus, so that we can identify where we want to go and the path that we must follow to achieve it."

* No person or entity will be responsible or liable for any errors, omissions or inaccuracies in this article or liable to anyone for any loss, damage, injury or expense suffered or incurred as a result of reliance on the information provided and opinions expressed in the article. Disclosure documents are free and available upon request.

Are you interested in being the subject of a free MoneyMakeover for The Press? Email amanda.morrall press.co.nz

- © Fairfax NZ News