What are Management Accounts?
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Who Produces Management Accounts?
Why Do a Significant Number of Businesses Lack Management Accounts?
- Lack of interest
- Oversight or never being properly considered
- Size deemed too small
- Incorrectly perceived as too small (when they’re not)
- Simply not initiated
- Absence of a formal accounting system
- Assumption of insufficient or inadequate in-house expertise
- Concerns about complexity
- Viewed as unnecessary
- Believed to be unaffordable
- Overwhelmed with other responsibilities, feeling too busy
What Do Most Businesses Do and The Result?
It’s quite common for businesses to overlook the production of management accounts altogether. Many operate without a clear understanding of their financial performance, relying instead on assumptions that often prove inaccurate. For instance, consider an Estate Agent with branches in three towns; when asked about the profitability ranking among their offices, the owners had no concrete data and resorted to estimation. Subsequently, when proper management accounts were implemented, they discovered their assumptions were far from accurate.
Typically, businesses track their sales, monitor their order book, and may have a vague understanding of their bank balance. However, beyond these basic metrics, they lack insight into their profitability, the relative performance of different business segments, overhead costs, and fail to compare performance over time. This lack of basic financial information leaves them vulnerable to underperformance or being blindsided by unforeseen challenges, such as cash flow shortages.
Moreover, the absence of proper financial information increases the risk of overtrading, where businesses expand sales too rapidly, depleting cash reserves or working capital. This scenario often catches business owners off guard, leading to financial distress. Timely and accurate financial information would highlight such issues, enabling corrective action before it’s too late.
Even when management accounts are produced, they may fail to provide essential insights. For example, a consultancy firm with multiple projects totalling £4 million in revenue lacked individual project profitability data, hampering their financial control and decision-making.
In our 15 years of experience, we frequently encounter clients facing challenges related to their management accounts, ranging from delays in reporting to inadequate quality.
If you’re committed to enhancing profitability, it’s crucial to receive timely, relevant information tailored to your business’s specific needs, determined by you and your team. It’s essential to take ownership of this process to extract the maximum benefit from the information available.
Addressing issues surrounding management accounts may seem daunting, but in our experience, they are often straightforward to resolve and immensely valuable.
It’s imperative not to adhere blindly to inherited reporting formats without evaluating their suitability. Circumstances change over time, necessitating adjustments to reporting practices to align with evolving business needs.
This principle applies equally to charities, where having accurate financial information is paramount, given the personal liability of trustees.
A significant improvement in reporting systems involves segmenting the Profit & Loss report according to different business segments, as exemplified by Affinity Outsourcing’s separate reporting for Bookkeeping with Management Accounts and Payroll. This approach allows for a clearer understanding of each business’s performance and profitability.
One of the most challenging hurdles to overcome is acknowledging a lack of understanding. Service providers can assist in this process, but ultimately, it’s up to individuals to confront this reality and seek assistance where necessary.
Who Uses Management Accounts?
- owners/managers
- investors
- banks/lenders
- factoring/invoice discounting
- accountants
- tax planners
Why Produce Them?
Operating a business without management accounts is akin to navigating a vehicle in the dark. You might gauge your speed by the wind noise and vibrations (representing sales), but without visibility, you’re unaware of your direction (profitability) and impending obstacles (cash shortages and liquidity issues).
Many businesses lack insight into their profitability, margins, and trends. However, it’s crucial to consider why these matters. The fundamental principle is that what can be measured can be improved. Therefore, if increasing net profit is a goal, the importance of management accounts becomes clear.
Financial reporting serves several key objectives:
- Assessing past performance to inform improvement strategies.
- Preventing cash flow challenges and managing liquidity effectively.
- Providing insight into future prospects.
- Identifying areas of focus to enhance profitability.
Management accounts furnish the necessary information to evaluate the performance of each aspect of the business, enabling informed decision-making to drive future success.
Some Specific Reasons for Producing Management Accounts:
- Assess the gross margin percentage, calculated by dividing the gross profit (sales minus direct costs) by the sales value, excluding VAT. This metric allows for benchmarking against peers in the industry, tracking performance over time, and taking proactive steps to enhance profitability.
- Implementing management accounts fosters financial discipline and can unearth inefficient practices within the business.
- Improved financial data provided by management accounts can streamline year-end accounting processes, potentially reducing associated costs.
- Determine the break-even point for profitable sales, enabling informed decision-making regarding pricing and sales strategies.
- Monitor and regulate overhead costs to optimize efficiency and profitability.
- Keep track of stock levels to identify trends and benchmark performance against industry standards.
- Manage debtors effectively by monitoring trends and comparing against benchmarks to ensure timely payments.
- Optimize the working capital cycle by efficiently managing stock, debtors, and creditors.
- Stay attuned to changes affecting the company’s bank position and take proactive measures to maintain financial stability.
- Utilize key performance indicators (KPIs) to provide quick insights into the company’s performance and identify areas for improvement.
Gross Margin Percentage
Many businesses overlook this critical information, yet its accurate measurement holds immense importance. Consider this scenario: if your annual sales amount to £500,000, a mere 1% increase in your margin translates to a £5,000 boost in net profit. The value of monitoring your margin becomes evident when you:
- Analyze the trend over time: Understand the reasons behind fluctuations, whether they’re upward or downward.
- Scrutinize every component of the margin, including sales and direct costs: Identify areas for improvement, such as eliminating unprofitable sales or cultivating relationships with lucrative customers.
- Monitor the margin diligently on a monthly basis: Investigate promptly any changes to ascertain their causes.
- Benchmark against peers in your industry: Evaluate your performance relative to competitors and ascertain opportunities for enhancement.
Marketing for Profit Using Management Accounts
Imagine you sell £2,000 worth of products in a month, with direct costs amounting to £1,200. This leaves you with a gross profit of £800, resulting in a gross margin of 40%. Typically, businesses focus on increasing sales to boost profits. However, consider this: a 10% rise in sales yields an additional £80 in profit, but achieving the same £80 increase in profit requires only a 10% improvement in margin, raising it to 44%, without the significant effort of increasing sales.
To illustrate further, if your margin were to decrease to 36%, you’d need a 10% increase in sales just to maintain the same level of profit. Without management accounts, tracking such changes in margins becomes challenging, hindering profitability optimization.
Once you’re aware of your gross margin as a percentage of sales, you gain the flexibility to experiment with pricing strategies as part of your marketing approach. This allows you to avoid the risk of pricing errors that could jeopardize your business’s financial health.
Many business owners instinctively lower prices when sales are sluggish, assuming it’s the best solution. However, this often leads to decreased profitability. Management accounts may reveal that raising prices could be a more effective approach.
Consider this scenario: a product priced at £10 with a gross margin of 25%. Decreasing the price by 10% to £9 necessitates a 66% increase in sales volume to maintain the same profit (£250). Conversely, increasing the price by £1 to £11 enables you to sell nearly 30% fewer units and still achieve the same profit. Thus, the path to enhanced profitability often lies in price increases rather than reductions.
Sale Units | Sale Each | Cost Each | Gross Profit Each | Gross Profit Total |
|---|---|---|---|---|
100 | £10 | £7.50 | £2.50 | £250 |
166 | £9 | £7.50 | £1.50 | £250 |
70 | £11 | £7.50 | £3.50 | £245 |
Consider this scenario: Which is more probable – increasing the price by £1 per unit and witnessing a decrease in sales by 30 units or less, or decreasing the price by £1 per unit and observing an increase in sales by 66 units or more?
How Are Management Accounts Produced?
Ensuring a robust accounting system is the primary prerequisite. While complexity isn’t necessary, reliability is paramount. Whether utilizing Sage, Xero, or Excel, it’s crucial to have an expert validate its integrity. While opinions on who qualifies may vary, engaging a qualified accountant is a prudent initial step. This needn’t always incur significant costs and may even be free at times, yet it’s a vital one-time assessment. An unreliable accounting system can lead to the generation of inaccurate or misleading reports, potentially resulting in erroneous decisions.
With reliable information in hand, crafting reports tailored to your specifications becomes relatively straightforward, even for small businesses with basic accounting skills. While assistance may be required, the investment is likely worthwhile.
At Affinity Outsourcing Ltd, we offer tailored management accounts through our Advanced system, precisely aligned with your needs.
What Skills Are Required to Produce Management Accounts?
- Conducting bank reconciliations – This is absolutely crucial; it’s essential to provide concrete evidence of this process rather than making assumptions. When uncertain, consulting with your accountant for validation is advisable, as this task can be swiftly completed.
- Reconciliation of VAT – This task is typically overlooked in many cases.
- Reconciliation of PAYE & wages – Similarly, this aspect is often neglected.
- Maintaining an organized and up-to-date sales ledger, including accurate debtor information.
- Maintaining an organized and up-to-date purchase ledger, including accurate creditor information.
- Managing stock and work in progress, particularly if your business involves fluctuating values.
- Handling accruals & prepayments – This aspect is frequently overlooked.
- Managing depreciation calculations.
What Do Management Accounts Look Like?
Management accounts can be generated from various accounting systems such as Sage, Xero, or Excel. It’s essential to ensure that the chart of accounts is well-structured, avoiding any missing or duplicate accounts.
While Excel offers more flexibility, it’s crucial to reconcile your data with your primary accounting system, unless your system is solely based on Excel. Failure to do so could lead to inaccurate information, defeating the purpose of producing these accounts. If your accounting system relies solely on Excel and includes a cash book summary, ensure that it aligns with your bank account records.
It’s important to recognize that these accounts provide a snapshot of the cash position, which differs from the comprehensive view offered by a profit & loss statement. While profit & loss reflects performance over a specific accounting period, the cash position indicates cash balances at a particular moment. Ideally, your reports should incorporate budgets, enabling comparisons with your targets for sales, gross margin %, overheads, etc. Additionally, if your business can be segmented into sectors, departments, locations, or projects, consider generating separate reports for each.
The insights gleaned from these reports are often eye-opening and pave the way for effective profit-driven management decisions. You can easily compare current results with previous years or multiple years to discern trends. Delving deeper, you can analyze your top-performing customers and products, allowing you to strategize ways to enhance or replicate their success.
What To Do with Management Accounts Outside the Business?
Impress your lender with factual insights, which they often lack. Consistent reporting, regardless of whether the news is positive or negative, demonstrates transparency and responsibility. In particular, providing commentary and a plan to address any challenges will be highly valued, setting you apart from businesses that neglect reporting. Quality Management Information (MI) significantly enhances your chances of securing financing and obtaining favorable rates, as banks prioritize well-informed decision-making.
Regular reporting to investors is not only appreciated but often considered essential for maintaining trust and confidence. Similarly, sharing management accounts with factoring or invoice discounting providers strengthens your relationship and instills confidence in your financial stability.
Utilize management accounts to leverage the expertise of your accountants or part-time Financial Director, who can provide valuable insights into performance and assist in tax planning. Additionally, these accounts serve as a basis for securing additional funding at lower costs, enabling business expansion and investment.
Management accounts serve as a crucial tool for business owners, offering invaluable insights akin to a pilot’s dashboard guiding an airplane. They provide early indicators of negative trends and inform strategic decisions, ultimately optimizing profitability. Enhanced profitability not only allows for increased investment in the business but also fosters future growth opportunities. Without management accounts, the outlook for a business is less promising, underscoring the importance of adopting this financial management tool.
An Overview
If you track it, you can improve it – simple as that.
How Can Affinity Outsourcing Ltd Help with Management Accounts?
To find out how Affinity Outsourcing Ltd can help your business with Management Accounts, please call us on +44 20 3965 3358 or email [email protected]. We look forward to helping you with your business.
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