Background

Contracts are vitally important to small businesses. They not only protect companies from legal risk but also help small businesses clarify and enforce their business rights and responsibilities. A written contract is not the only way, though, to create a legally binding agreement; oral agreements are also effective in making contracts legally enforceable.

If you want to keep your small business in the clear, you must make sure to use contracts as part of your overall business strategy.

Working with smaller businesses can be a good thing, but there are pitfalls. Startups and small businesses tend to work informally, which can be dangerous because of the legal and financial implications.

Contracts are useful for small businesses because they can help to avoid disputes, ensure that all business partners are on the same page, and serve as a record of the agreed terms.

When you are collaborating with employees, clients, suppliers, consultants, or cofounders, it is important to have a contract or agreement in place that outlines your responsibilities and expectations. This document can serve as a reference in case there is ever a disagreement or problem between the parties.

Even if a contract is about legal matters, it can create financial obligations for you, the other party, and sometimes even third parties. Having no contract can also create financial obligations.

There are three types of contracts: written, oral, and implied. Written contracts offer more proof of a transaction or event than oral contracts, which rely on mutual understanding between the parties to the contract. In this article, we will focus on written contracts as they offer a lot more proof than oral ones.

Typical contracts and their financial implications

Strictly from a financial standpoint, here are a few contracts or agreements to have in place whilst starting or growing your small business or startup:

1. Partnership or Ownership Agreement

When two or more people start a business, they need to decide how they will divide up ownership. A partnership agreement is an important way to define these relationships.

Moreover, small businesses can avoid disagreements about who is responsible for specific acts by forming a partnership agreement. The agreement must state the contributions (financial and non-financial) expected of each partner. It should show how much money each partner will get and when they will get it.

An ownership contract is a legal agreement between two or more people that specifies their respective stakes in a corporation, as well as their duties and obligations.

When a business receives investment from a corporation, venture, or person in exchange for a percentage of ownership, it should revise the ownership agreement accordingly.

Accounting wise, this helps identify:

• Capital
• Transactions with owners (related party transactions)
• Owners’ salaries (with tax implications)
• Dividend sharing

2. Employment agreement

An employment contract is a written agreement that explains how much money an employee will get and the payment dates. It also includes the employee’s leave entitlements and any other extras that the employer provides.

Both the employee and the employer should be aware of their responsibilities and duties, as well as any workplace limitations that may apply.

Each staff member of a business should have an employment contract that lists all remuneration and benefits owed to them.

Accounting wise, this helps identify:

• Gross Salary
• Personal Income Tax Deductions
• Pension Deductions
• Other deductions
• Other Benefits
• Net pay

3. Sales contract

When you make sales on credit terms, it is important to have a signed contract.

A sales contract outlines the terms of the sale. It can include payment terms and the length of time it will take you to receive payment. It also includes information about when you need to give an invoice to your customer, so they know how much they owe you.

To protect against the risk of unpaid receivables, it is always advisable to have an enforceable agreement for every credit sale.

Accounting wise, this helps identify.

• Gross Sales
• Receivables (due and overdue)
• Contract assets
• VAT on Sales
• WHT on collection
• Interest on unpaid receivables
• Rebates and discounts
• Provisions for warranties

 4. Purchase contract

This is the opposite of the preceding sales contract, and it is normally not necessary if the vendor has already delivered their sales contract. Just like with the sales contract, a purchase contract can include the same information from your company’s perspective as a buyer.

Before you acquire goods or services, review the payment terms to learn whether you will receive payments before or after meeting certain obligations. You can also negotiate discounts, incentives, and other provisions.

Accounting wise, this helps identify:

• Purchases
• Payables (due and overdue)
• Accruals
• VAT on Purchases
• WHT on payments
• Interest on unpaid payables
• Rebates and discounts
• Inventory
• Cost of Sales

5. Lease contract

Generally, small businesses lease rather than buy assets. Office space is one of the most common assets leased. Some small companies lease equipment such as automobiles and computers.

Furthermore, the lease contract outlines the conditions and payments associated with renting or leasing real estate or other assets. It also describes the responsibilities of both parties (the lessee and lessor) and what happens if either party fails to comply with the contract.

All things considered; we can identify the following:

• Leased assets
• Lease obligations
• Provisions
• Interest on lease obligation
• Lease expenses
• Prepayments and deposits
• Accruals

6. Loan Agreements

A loan agreement sets the terms on which a lender may lend money to a borrower whilst also establishing certain duties and obligations for both parties.

The purpose of the contract is to define what will happen for late repayments; periodic payments; if compound interest will apply and for how long; security for the loan; and penalties for defaults.

Like the lease agreement, many businesses enter into loan agreements with banks or financial institutions and simply sign the lender’s “standard” form. The standard form tends to be very one-sided in favour of the lender, with various restrictions on the borrower.

Accounting wise, this helps identify.

• The value of loans and borrowings (current and non-current)
• Interest paid during the year
• Interest accrued at the end of the year
• Property, plant, and equipment secured on a loan
• Provisions for penalties for defaults

7. Independent contractor agreement (IC)

In small businesses, independent contractors and professional firms are more likely to do work. Independent contractors’ agreements must be clear in terms of roles and responsibilities. The agreement could be a one-off or on a retainer basis.

Primarily, an independent contractor agreement documents the relationship between the independent contractor and the client. The contract will have specific terms of engagement: rates, time frames, and deliverables. It can also include liability and non-compete clauses.

In addition, this contract can also set out terms and conditions of employment in a written contract form. Written contracts will help guide business owners or operators through legal processes such as court litigation to ensure they comply with their obligations under law when it comes to paying staff.

For instance, many small businesses are unaware of statutory requirements around independent contractor agreements and the legal implications of non-compliance. This is relevant for small businesses in contract work situations, such as subcontractors.

In conclusion, we can identify the following:

• Professional fee expense
• Accruals for unpaid professional fees
• WHT on payment.

Conclusion

Other important business agreements include service contracts, non-disclosure agreements, non-compete agreements, and assurances. In some cases, it is best to get legal advice before signing these documents.

Finally, by implementing these contracts, your company can expect more transparent and comprehensive accounting, which will not only protect but also increase the value of the organization. The organization should update these contracts as necessary to reflect changing circumstances.

If you have any questions or concerns regarding the financial implications of your business’s contracts and agreements, please feel free to contact us.