In this the final of a three part blog we look at Marketing for Profit using Management Accounts, how Management Accounts are produced and what to do with Management Accounts outside of the business.
Marketing for profit using management accounts
Suppose you sell £2,000 of product in a month and your direct cost is £1,200, your gross profit is £800 which is a gross margin of 40%. To improve profits the tendency is to focus on sales. A 10% increase in sales will generate £80 more profit but a 10% increase in margin to 44% would increase profits by the same amount without the significant effort required to increase sales.
To put it another way if the margin dropped to 36% you would have to increase sales by 10% to stand still. But if you don’t have management accounts you cannot know what is happening to your margins. Thus without management accounts it is difficult to optimise profitability.
Once you know your gross margin as a percentage of sales you have the knowledge to experiment with price changes as part of your marketing mix, without the danger of going bust because your margin is wrong. If sales are not too good, many business owners think the best thing to do is trade their way out of the problem by reducing prices to win more sales. Whereas in many cases this is the worst thing to do, as it often has a negative effect on profits. Management accounts may show that increasing prices could be the better option.
Take the following scenario. For a product selling for £10 with a gross margin of 25%, reducing your price by 10% to £9 means you have to sell 66% more to make the same profit as before, (£250), yet increasing your price by £1 to £11 means you can afford to sell almost 30% less units and still make as much profit. The route to increased profits can often be through price increases, rather than price reductions.
|Sale Units||Sale Each||Cost Each||Gross Profit Each||Gross Profit Total|
Which is more likely to happen, price up by £1 per unit and sales fall by 30 units or less or price down by £1 per unit and sales up by 66 units or more?
How are management accounts produced?
The first requirement is a sound accounting system. This need not be complicated, but it needs to be sound. This might be Sage, Xero or even just Excel, but whatever it is someone who knows what they are talking about should check its soundness. It’s a matter of opinion as to who is capable, but a qualified accountant would be a good starting point. This need not cost a lot, sometimes it’s free but it’s an essential one-off check because if your accounts are unsound they you will produce unsound or misleading reports and hence you may make wrong decisions.
Armed with sound information it’s then quite straightforward to design reports to your requirements, even for a small business with modest accounting skills. You might need help but it will probably be worth the investment.
What skills are required to produce management accounts?
This is a bit tricky to answer because to a certain extent it depends on what they are being used for but generally the book-keeper, with possible assistance at a month end, needs to be capable of covering the following:
A bank reconciliation – absolutely essential, you must prove that you have this and not assume anything. If in doubt check with your accountant, it’s a 10 minute job.
• Reconciliation of VAT – usually not done
• Reconciliation of PAYE & wages – usually not done
• Sound up to date sales ledger i.e. debtor information
• Sound up to date purchase ledger i.e. creditor information
• Stock and work in progress if your business has changing values
• Accruals & prepayments – usually not done
But beware – only top book-keepers achieve all of the above so take very special care when recruiting as you will be putting all your trust in this one person. Thoroughly check references and find someone to check their skills, perhaps your accountant. What you are looking for is a reconciler, not just an input clerk.
What do management accounts look like?
They can be produced from your accounting system such as Sage, Xero or in Excel. Check that the chart of accounts is sound i.e. not missing any accounts or duplicating accounts.
Excel is more flexible but it’s important to reconcile to your accounting system (unless that is just Excel) otherwise you may show wrong information which rather defeats the objective. If your accounting system is just Excel and you have just a cash book summary then ensure that this reconciles to your bank account.
You should also realise that this would be purely a cash picture, which is not the same as a profit & loss. Profit & loss is a measure of performance over an accounting period, whereas cash position is a snapshot picture of cash balances at a specific point in time. Ideally your reports will include budgets so you can compare against your target. What do you expect for sales, gross margin %, overheads etc? Where the business can be split into sectors/departments/locations/projects then separate the reporting accordingly.
The results are often surprising and will lead to effective profitable management action. It’s easy also to compare against previous years or even a number of years. What does the trend look like? You can go below the surface and check your top performing customers and products – then aim to boost or replicate.
What to do with management accounts outside the business?
• Impress your bank with some facts, it’s what they are normally desperately missing. It’s best to report regularly, good or bad. Infact accompanying bad information with some commentary and plan to fix will be much appreciated, it will certainly mark you out from other businesses who simply don’t report. You are much more likely to win a facility and at a better rate with quality MI (Management Information) as the banks say.
• Report to your investors – this will be really appreciated if not essential
• Issue to your factoring or invoice discounting provider
• Allow your accountants or part time Financial Director to advise on performance
• Allow your accountants to plan your tax affairs
• Use as a basis for obtaining more and lower cost facilities
So what can we take away from this as we reflect back on this and our two previous Management Accounts blogs? Management accounts offer business owners the opportunity to gain critical insights into the financial side of business performance. They can give a ‘dashboard’ just like a pilot needs to guide an aeroplane. On the one hand, management accounts can give early warning signs of negative trends, while
on the other hand, the insights gained lead to better business decisions, which will allow you to optimise profitability.
Naturally, higher profitability enables greater investment in the business and hence facilitates future growth. Without Management Accounts the picture is a lot less rosy and the prospects for a business not as good.
Contact us for help with putting good quality management accounts and management information in place.