Nexia Pulse

Antidote to Economic Downturn:
Battening Down The Hatches - A Taxation and Cash Flow Management Perspective

This article is authored by Edwin Leow (Tax Director, Nexia TS) and Chan Yee Hong (Director, Forensic Accounting & Insolvency, Nexia TS)

2017 appears set to be a unique and distinctive year on a number of fronts. Potential opportunities contrast sharply against the backdrop of an uncertain and challenging global economic environment. Not since the 1930s has such a combination of falling growth, increasing pessimism and the looming spectre of economic protectionism cast such a pall on the global outlook.

The US election victory of Donald Trump has no doubt brought some temporary cheer to global markets on the back of promises of a huge fiscal stimulus in combination with regulatory roll-backs. Having relied heavily on monetary easing by central bankers to support growth, it is unsurprising that markets have cheered these developments with gusto. Tax cuts and infrastructure spending are expected to reflate the US economy which in turn will hopefully do the same for the rest of the global economy. That in itself, however, may not be enough to counter the downward draft being generated by the stalling Chinese economy and lack of consumption demand in the developed markets of the world. Here in Singapore, despite a better than expected full year growth figure of 1.8% for 2016, these headwinds are expected to persist and remain challenging for the economy in the near term.

It is a fact that any fiscal stimulus enacted would need to be financed in some way or other, the chief method being increased taxation. And therein lies the predicament. In many countries, high household debt and a struggling corporate sector already burdened with low profitability and weak balance sheets are likely to complicate any efforts to impose further tax increases. In an environment where countries potentially have to resort to higher taxation to fund their fiscal programmes, businesses may start feeling the pinch if these measures by tax authorities to extract their pound of flesh from the economy start impacting them negatively. So what can the government and the private sector collectively do to ensure that businesses particularly the Small and Medium Enterprises (SMEs) survive an economic crunch?

Fiscal & Taxation Measures

Firstly, there has in recent decades already been a shift in emphasis to indirect taxation which is aimed at imposing taxation at the point of consumption rather than at the income or profits level. This is beneficial in that governments still achieve their revenue targets by levying tax on a significantly broader tax base while at the same time maintaining a competitive income tax rate which is crucial to promoting business activity and attracting foreign investment from abroad. For this reason, the shift towards indirect taxation is becoming more pronounced worldwide with many countries either enacting tax reforms to introduce it or to increase the applicable rates within their existing indirect tax regimes. Malaysia, for example, adopted a Goods and Services Tax regime in 2015 while Japan has announced a two percentage point increase in its consumption tax rate which is set to take effect from 2019. In certain countries, such moves have gone hand in hand with a steady reduction in the headline corporate tax rates. This can only be a good thing given the fact that capital ultimately needs to be allocated towards its most efficient use and investors always look at net returns on an after-tax basis when making decisions about where to invest.

Secondly, tax incentives continue to play a key role in stimulating economic activity and takes on outsized importance in incentivising companies to maintain their business operations in the host country and indeed to survive major economic downturns. In the case of Singapore, tax incentives such as the Headquarters Programme and Global Trader Programme grant attractive concessionary rates of corporate taxation to companies that meet certain prescribed qualifying criteria. More importantly, the ecosystem of such incentives also includes a broad suite of grants and even measures such as the Productivity & Innovation Credit scheme which is embedded within the corporate tax system. Companies, particularly SMEs, should take full advantage of such measures to cushion the negative impact of any downturn and to perhaps even leverage such measures to help them grow, scale up or internationalise during this period to capitalize on any retreat by their competitors.

Thirdly, countries facing the prospect of slow growth and trade constraints in a potentially more protectionist environment could take a leaf out of the United States’ playbook and go down the same fiscal stimulus route. Economic downturns tend to be self-fulfilling in that any collapse in demand reverberates and transmits itself through various channels resulting in further contractions which ultimately create a downward spiral. To stave off the pernicious effects of an uncontrolled spiralling collapse in demand, governments can step in as a “spender of last resort” to prevent such a collapse in demand. Often this could be just the shot in the arm that the economy needs and a boon to businesses, particularly the SME sector which is often the hardest-hit segment of the economy.

In Combination With Prudent Cash Flow Management

In an economic downturn, the most likely affected are the SMEs. Suddenly, SMEs find themselves financially strained by falling business and slower payments by customers. Inadvertently, SMEs find their cash reserves dwindling and increasingly harder to pay liabilities when they fall due.

While the government initiatives will buttress the cash flow of SMEs, more needs to be done by the SMEs to equip themselves to address existing business challenges and uncertainties brought about in an economic downturn. Cash flow management is perhaps the most direct antidote SMEs can employ and have influence over to cure the financial illness associated with an economic downturn.

Simply put, cash flow management refers to actions management actively takes to calibrate its cash inflow and outflow to ensure, amongst others, debts will be paid when they fall due. These obligations include staff salaries, rental, loan repayment and cost of supplies. Insolvency arises when a company cannot pay its debts when they fall due and is a common financial covenant, if breached, would bring a company closer to bankruptcy if not rectified expeditiously.

To SMEs which are low on funds or reserves, solvency takes priority over profitability. This is because a company which cannot pay salaries to its employees is unlikely to be able to continue operations even though the business is profitable. Hence, the importance of cash flow management cannot be over emphasised.

To build a prudent cash flow model, a company must first determine how much cash it needs to operate its business over a specified period of time. Drawing up a cash flow analysis will, in addition to identifying cash requirements, reveal the strengths and weaknesses of a company’s cash flow position. This sets the precedent for further review and modification of the business model or operational framework to generate a consistent cash inflow sufficient to meet its debt obligations, and if possible, build a reserve. For example, discontinue less profitable product lines, offer attractive discounts to entice early payment by customers, dispose of non-core assets to raise cash, discontinue legal suits, and downsize operations or defer expenditure to reduce cash outlay.

The objective of the above examples is to bring in and conserve much needed cash. While some measures may result in losses for a company in the short term, they are crucial for survival of companies in liquidity trap in the long term. An economic downturn will only add further pressure on the cash flows of companies. However, such and other measures SMEs may adopt in tackling challenges of an economic downturn may also help them evolve stronger in a transforming economy.

CONTACTS
For more information, please contact:

Mr Edwin Leow
Tax Director
edwinleow@nexiats.com.sg

Mr Chan Yee Hong
Director, Forensic Accounting & Insolvency
yeehongchan@nexiats.com.sg