using tax reserves to fund cash reserves

starving_artist

I'll do my best to explain this: My friend wants to set up a business with two others as a limited liability partnership. Voting rights will not be equal nor will the profit share as the other two are part time and with different levels of expertise. None of them want to put up cash for working capital. An accountant has suggested that they pay themselves drawings each month 'net' of what their nominal monthly earnings should be. The tax element of all the drawings would then be retained in the business along with any profits for use as a cash reserve until the end of the year when it would all be paid out.
Is this kind of arrangement good/normal practice? Surely mixing each partner's personal finances with the business's when the contributions, personal liabilities and tax rates will be different for each one is just going to become hugely complex?

CKhalvashi

It's only a good way to do things if you're sure of the cashflow of the business year round.

We more/less double in size in last week June, whole of July/August and the last week in December, compared to being relatively quiet the rest of the year (although year-round, we're not a small company anyway). Taking that into account, it would be risky for us to do it.

paddyrg

It's doable, but would seem hazardous to me. Cash is the most important part of a stable business. Having cash to hand means being able to pay odd bills, take advantage of sudden offers, etc. If the company is so cash starved that it's using any monies withheld for HMRC, there's the huge risk that through undercapitalisation they'll suddenly have to find the money from somewhere. If that happens, and they are selling assets urgently, they're the wrong side of that 'sudden offers' bargain, they're in fire sale mode. That, in turn, puts everything else at risk.

Personally, I play conservatively for the long term company health. I'd suggest the LLP isn't healthy or old enough to pay three sets of salary if in doing so it exposes itself to catastrophe. Perhaps everyone should stick to 50% salaries for first 6 months, then 75% for the next 6 months or year. Then there will be working capital, then the problem has gone away.

bengalknights

The only hazard is ensuring there is sufficient cash flow at the end however there is nothing wrong with the advice given

antrobus

starving_artist wrote: »

I'll do my best to explain this: My friend wants to set up a business with two others as a limited liability partnership. Voting rights will not be equal nor will the profit share as the other two are part time and with different levels of expertise. None of them want to put up cash for working capital. An accountant has suggested that they pay themselves drawings each month 'net' of what their nominal monthly earnings should be. The tax element of all the drawings would then be retained in the business along with any profits for use as a cash reserve until the end of the year when it would all be paid out.
Is this kind of arrangement good/normal practice?

It's perfectly good and normal practice for an accountant to advise a client only to withdraw post-tax profits from a business. All the accountant is saying is, take tax into account when you make your drawings, and leave enough profit behind to pay your taxes.

You are simply overcomplicating things with your talk of cash reserves, and tax reserves.

starving_artist wrote: »

...Surely mixing each partner's personal finances with the business's when the contributions, personal liabilities and tax rates will be different for each one is just going to become hugely complex?

The partnership doesn't pay any tax on it's profits. The partners pay tax on their share of the profits, so of course each partner's liability will (potentially) be different. That is complexity that cannot be avoided.

starving_artist

Thanks all. Will feed back your comments.