"SME owners, start swimming to avoid drowning. Your take home could reduce by 9.5% a year if you don't."

Jim Shaw
Founder & CEO, Shaw & Co

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Has anyone done the maths yet? No? Well I have and what I can tell you following recently announced changes to Employers NIC and Corporation Tax rates along with forecast cost inflation and wage rises, many SME owners are going to lose out. The government talks of the 'strong economy needed to drive Britain' yet it is set to leave those of us (yes us, I am an SME owner as well) at risk of drowning for the privilege of creating that economy Rishi Sunak was lauding this Budget. I'm left wondering, is this Government pro business, or is it waging a war on business?

"It's mathematically impossible for an average SME owner to keep up with inflation in their annual take home."

Jim Shaw

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With a little spare time on my hands this weekend I set myself to thinking, how would a modest SME owner fair in 2023/24 if the inflation predictions made in this weeks Budget came to pass? My hypothesis was that with cost inflation, wage inflation, additional NIC contributions, higher Corporation Tax rates all around the corner, without underlying 'real' growth, it's mathematically impossible for an average SME owner to keep up with inflation in their annual take home. Simply these business owners are going to go backwards if they don't start swimming hard, and now.

My conclusion is that the owner of a modest business turning over £1m per annum will take home £2,907 less in 2023/24 than they did in 2021/22. However, taking into account expected inflation in household costs this will equate to a shortfall of £8,170 or 9.5% of the income needed to 'stand still' in an inflationary environment.

There will be a lot of the population who will rightly claim, first world problem. My example business owner here is taking home £80,410 after tax. An income well above the national average. However, there will be a large number of people for whom my fictitious example will be very close to the truth. They will have 'sized' their monthly expenditure on this income level and could be facing real adjustments in the coming years if they don't grow their way out of the problem.

Business owners are however optimists by nature (if they were not they would be employed and likely in the public sector) so no doubt they will be quick to back themselves to grow 20%, 30% per annum or more. However, I was interested in just how hard hit the business owner will be simply through the impact of the macro-economic environment we see ahead of us.

Is the government failing SME owners?

I watched the budget, I saw our Chancellor, Rishi Sunak, time and again talk about 'a strong economy' allowing the investment in public services. An additional £150bn thereabouts. But I don't see where the reward is for the people that get up every morning and make this happen.

The impact of SMEs on our economy is massive. It is the engine room of economic growth. However, in this budget this critical sector of the economy is subject to an unprecedented raid in order to fund the spend, spend, spend on public services designed to keep the Labour party in the wilderness.

By my maths, not only will huge numbers of SME owners receive no support to create this 'strong economy' they are going to find themselves going backwards in relation to their employed counterparts. What incentive therefore to run your own business, create jobs and drive growth?

Add to all this the removal of Entrepreneurs Relief with life time limit of £10m and thus a potential tax benefit of £1m to be replaced by the measly Business Asset Disposal Relief of with a limit of £1m thus delivering a benefit of £100,000, you are left scratching your head.

"Is this Government pro business, or waging a war on business?"

Jim Shaw

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A perfect storm

One should also remember that the very people we are talking about here, have just navigated the most frightening (yes I use that word purposefully) trading period in living memory. COVID hit many businesses hard. These business owners are carrying scars, struggling to adapt business models. They are dealing with staff and raw material shortages mainly due to an appallingly handled Brexit. In addition they have VAT deferrals to pay, Bounce Back Loans or CBILS loans to be repaid and commonly Business Rates deferrals that now needing settling.

Would it not have been more prudent of the Government to give business space to recover and rebuild? The additional 1.25% on Employers NIC and additional 6% on Corporation Tax adds insult to injury for many. The freeze in Income Tax personal allowances and rate bands to 2026 is an effective tax increase over the fiscal period. This does nothing to alleviate the wage pressure when employees are feeling the pinch, and are in short supply. It would have been wise for the Government to share some of this burden through allowance and band increases over the period. They have chosen instead to quietly collect this benefit and spend, spend, spend. Again expecting industry, and the SMEs, to deal with the problem.

Scaling up the example

Many SMEs are much larger than my example, and to be honest our clients at Shaw & Co would be more regularly in the £1m+ EBITDA bracket than £1m turnover bracket. However, similar considerations are relevant. There will be more room for increased dividends to support those more successful business owners on a personal level and maintain the status quo at home. However, for a business with the aim of generating the same cash in 2023/24 as 2021/22 the conclusion is the same - you have to move forward a pace to avoid going backward.

Failure to 'get swimming and keep swimming' will manifest itself in less free cash flow, therefore less investment in growth creating a noose that doesn't take long to tighten.

Or put it another way, the Government is using you, the SME owner and relying on your ability grow ahead of inflation to support the rest of the country. And if you don't? The risk of your head falling below the water line is real, the government have opened the sluice gates, we SME owners will have to start swimming fast if we aren't to drown.

Conclusion

We at Shaw & Co are focused on helping SME leaders achieve their greatest ambitions. We see first hand the challenges our clients face each day. Looking forward, its clear to us that we as a group are going to have to work harder than ever to make sure that we don't come out on the wrong side of these coming, potentially challenging, years. We certainly aren't being offered any assistance from the Government in the medium term.

The model assumptions

To build up my analysis I have had to make some pretty broad brush assumptions, but I bet I am not far off the money for a huge majority of SMEs. Here are the assumptions if you want to recreate my model.

1. Turnover £1m pa that the owner is able to successfully increase at the rate of general inflation assumption.
2. Cost of Goods Sold (COGS) of 50% of turnover, increasing inline with general inflation assumptions. Starting gross profit therefore £500,000.
3. Salary costs of £200,000 before employers NIC but including all other costs such as pension contributions. Inflating 3.5% per annum as suggested by the Chancellor.
4. Employers NIC in 2021/22 of 13.8% increasing to 15.05% in April 2022.
5. General overheads of £100,000 increasing inline with general inflation assumptions.
6. Profit before tax in 2021/22 of £172,400 or 17.2% of turnover, which is a good margin but we are assuming that the owner manager is rewarded through dividends.
7. Corporation tax increasing from 19% to 25% from March 2023.
8. SME owner pays £6,515 pa in salary to maintain NI contributions.
9. Company distributes 75% per annum in dividends retaining 25% for investment and balance sheet security.
10. Owner manager pre-tax dividend income 2021/22 of £104,733 and post tax of £80,410 per annum.
11. Dividend rates increased by 1.25% as announced for 2022/23 onwards.
12. Inflation 4.0% pa in 2022/23 and 3.0% pa in 2023/24.

If you would like a copy of my excel model to play with, email me at jim.shaw@shawcorporatefinance.com and I'll send it over.

Jim Shaw - Founder & CEO, Shaw & Co