Caroline

Management Accounts – Part two in a series of three blogs.

Management Accounts – Part two in a series of three blogs.

In this the second of three blogs we look at who uses Management Accounts, what are the reasons for producing Management Accounts?

Who uses management accounts?

• owners/managers

• investors

• banks/lenders

• factoring/invoice discounting

• accountants

• tax planners

Why produce them?

Running a business without management accounts is like driving a car in the dark. You know what speed you are doing from the wind noise and vibrations (your sales) but you don’t know your direction (your profitability) and you can’t see obstacles you are about to hit (shortage of cash & liquidity).

Most business don’t know their profitability, margins and trends. So why bother? It’s a fundamental principle that if you can measure it you can improve it so assuming you want to increase your net profit it’s rather a ‘no brainer’.

There are several key objectives in financial reporting:

• To measure past performance as a basis for improving

• To avoid cashflow problems and manage liquidity

• To have future visibility

• To determine where to focus attention in order to improve profitability

Some specific reasons for producing management accounts:

• Measure the gross margin percentage. Broadly this is the gross profit (sales less direct costs) you make from your service or product divided by the sales value, excluding VAT. Armed with this information you

can check your performance against others in your business sector. You can check trends over time and you are then in a position to take action to improve your profits

• It imposes a discipline of controlling the finances and may uncover bad practices

• It will tend to reduce year end accountants’ costs as the information will be better and more likely to be reconciled

• Establish your break-even point for profitable sales

• Check and control overhead costs

• Control stock levels – measure trends, benchmark it

• Control debtors – measure trends, benchmark it

• Manage the working capital cycle – stock, debtors and creditors

changing affecting the bank position

• Use key performance indicators (KPIs) to see at a glance what’s happening

 

Gross margin percentage

Most businesses do not know this information but it is really important to measure this accurately. Suppose you sell £500,000 per annum. If you can increase your margin by 1% your net profit will increase by £5,000. What is so beneficial is to check the margin as follows:

Check the trend over time – establish why it has changed, either up or down. Examine every part of the margin i.e. sales and direct costs to see what can be improved such as cutting out loss making sales, increasing sales to profitable customers etc. Examine it like a hawk as soon as it’s known each month – why has it changed? Benchmark against comparable businesses in your sector – how well are you doing, should you be improving?

Management Accounts – Part one in a series of three blogs.

What are they, why do so few businesses have any and what most businesses do?

 

What are management accounts?

Everybody has heard of management accounts, so everybody knows what they are. Well no, it’s probably the opposite, so let’s start with some explanation. Management accounts are financial reports produced for the business owners and managers, generally monthly or quarterly, normally a Profit & Loss report and a Balance Sheet. In principle they are similar to Year End accounts but are less formal and personalised to the reader’s requirements.

Who produces management accounts?

There are 5.7 million businesses in the UK. A surprising 98% have 19 or fewer staff, 96% have 9 or fewer and 75% are just 1 person. Only a tiny fraction of these 98% have management accounts.

Why do so few businesses have management accounts?

There is a mixture of reasons:

• lack of interest

• never properly considered

• too small

• thought to be too small (but are not)

• just never started

• no formal accounting system

• assumed insufficient or inadequate in-house skill

• worried about the complexity

• perceived as unnecessary

• assumed unaffordable

• another job to do – too busy

It’s fair to say that there will be some businesses that are truly too small or too simple to require detailed management accounts. However, they will still benefit from at least a basic, quarterly summary of some sort and comparison with previous periods. It’s a matter of opinion but arguably turnover of £100,000 is not too small to benefit from some detail.

What do most businesses do and the result?

The norm is that no management accounts are produced and never have been. Most businesses have insufficient systems in place to know their true financial performance – if they did then they would have a starting point, rather than just assumptions which are often wrong. For example, an Estate Agent with offices in three towns – when asked what the ranking of profitability was between the offices the two owners had no information. They put their heads together to estimate the ranking. In due course proper management accounts proved them completely wrong, yet they thought they were smart operators.


Typically, a business measures its sales, knows its order book and might have an idea of the bank situation. But that’s about all. It doesn’t know its profitability or lack of it. It doesn’t know which parts of the business are better than others – it just guesses or perhaps not even that. It doesn’t know its overhead costs and doesn’t compare performance month to month with previous years. In short, it’s woefully short of even basic financial information. Some businesses worry about this, others don’t but it stands to reason that if it’s measured it can be improved. When all said and done that’s what it’s all about – the bottom line net profit.


The result is that the business under achieves profit or is taken by surprise because difficult circumstances can arise without warning, in particular shortage of cash and liquidity. Most businesses end up taking financial decisions in the dark and that can’t be a good thing. Without sound financial information the business is at risk of significant or serious underachievement in either profit or cash or both.


Another key effect of no accounts is the risk of overtrading – that is expanding sales too quickly so that the company runs out cash or working capital. In short, customers may not have paid before suppliers and staff demand their money. This is a very common reason for firms going bust and it’s usually a huge surprise to the business owners. Proper financial information would highlight this happening so that corrective action could be taken before it’s too late.


Even if management accounts are produced they may be failing to produce vital information e.g. a £4 million consultancy with 19 projects – the problem here was that although the overall picture of the business was measured there was no split between the projects so the company had no idea of the profitability and lacked any financial control of individual projects

Look out for parts 2 and 3 of this Blog

 

This entry was posted in Accounting, Business Development, Funding, Management Accounts and tagged in Accounting by Caroline