Purpose of Management accounts
The information from Management Accounts informs how each part of the business has been performing and thereby guide decision-making to benefit the company’s future performance. Measure the gross margin percentage.
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, typically a Profit & Loss report and a Balance Sheet. They are like Year End accounts but are less formal and personalized to users’ requirements.
Why do so few businesses have management accounts?
There is a mixture of reasons:
- lack of interest
- never properly considered
- too small
- just never started
- no formal accounting system
- perceived as unnecessary
- assumed unaffordable
- another job to do – too busy
It’s fair to say that some businesses will be genuinely 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 actual financial performance – if they did, they would have a starting point, rather than just assumptions that are often wrong.
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 sadly 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. That’s what it’s all about, the bottom-line net profit.
The result is that the business underachieves profit or is taken by surprise because difficult circumstances can arise without warning shortage of cash and liquidity. Most companies make financial decisions in the dark, which isn’t a good thing. Without sound financial information, the business is at risk of significant or severe underachievement in profit or cash.
Another critical effect of no accounts is the risk of overtrading – expanding sales too quickly so that the company runs out of cash or working capital.
In short, customers may not have paid before suppliers and staff demand their money. It is a principal reason for firms going bust, and it’s usually a huge surprise to the business owners. Accurate financial information would highlight this is happening so that could take corrective action before it’s too late.
Even if they prepare the management accounts, they may fail to have vital information, if a company has many projects– the problem here was that although measured the overall picture, there was no split between the projects. Hence, the company had no idea of the profitability and lacked any financial control of individual projects.
Suppose you’re serious about improving your profitability. In that case, naturally, you’ll ensure that you receive prompt, every month, the critical and non-financial information you need to run your business effectively and efficiently.
Some issues are apparent and easy to identify, such as just no management accounts or they’re far too late or of poor quality. Personal user’ difficulties’ around the table tend not to be obvious or even admitted. These broadly fall into two categories.
The first is a simple lack of understanding of the numbers and what action to take.
The second is accepting a substandard form of reporting, perhaps assuming, probably wrongly, that it can’t change or that such would be too expensive.
A short reporting situation is a shame, but it’s worse. It potentially costs serious money if management decisions are being delayed or prevented because of the lack of quality MI.
Be cautious – it’s not a good idea to carry on with the detailed reporting you inherit without reviewing whether it fits your purpose. Circumstances may have changed over time, so the reporting needs adjusting, but this won’t happen automatically.
Of course, this applies equally to charities where arguably it’s even more critical to have the MI and understand it as Trustees are personally responsible.
They’re different businesses with different margins. If mixed in one, while you can still tell the sales performance, you don’t know which is improving its margin profitability and which is not – there’s no way of speaking.
Perhaps the most challenging obstacle to overcome is for a user to admit a lack of understanding; to a certain extent, that’s down to the service provider checking, asking, hinting, or otherwise. But it’s mostly down to the individual getting real.