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?
• factoring/invoice discounting
• 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?
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