What should a business owner do to make sure he has the best possible information at his fingertips? How do you start putting this accounting knowledge into practice?

We’ve already discussed how to identify the key transactions of the business. Also, how to record the information that’s important to your business and pull it into insightful reports. Now let’s look at how you put this all into action.

Making your finances work for you

With your understanding of the financial basics, how do you start putting this accounting knowledge into practice and making your finances work for you?

  • Firstly, you must have systems that are appropriate for the business. Decide who’ll be responsible for the recording of information. The methodology and the level of detail you get into will depend on the size of the business.
  • Secondly, you must list the types of reports you need. What types of information and analysis will help you prepare these reports easily. This involves adapting your accounting system to capture the information needed. Making sure it’s easy to pull the reports from the system, no matter how simple or complex.
  • Finally, you need to have a routine to help you check the information. You’ve no doubt heard the hackneyed phrase ‘garbage in, garbage out’ – it’s a truism that’s as applicable for accounts. When someone gives you financial information, you need to know how reliable this information is.

So how do we sanity check your reports? What should you be looking for when carrying out these reviews?

accounting-knowledge-practice

Using your reports in the right way

In my experience, when business owners get their financial reports, most of them jump straight to the profit and loss report. However, I’ve learned that it’s more important to start with the balance sheet.

I will ask you to remember the ‘Wile E Coyote and The Road Runner’ cartoon that was on television years ago…

The roadrunner was always speeding along a road, with milestones at the side. If he first passed the 5km mark and later passed the 15km mark, he knew (and we knew) that he’d traveled 10km in total. However, what if someone mistakenly put the 15km in the wrong place, say at 14km? The roadrunner would think he’d traveled 10km when he’d actually only traveled 9km!

By unquestioningly relying on the milestones, the roadrunner is misinformed and doesn’t correctly understand its performance.

Similarly, this applies to accountants. The balance sheets provide the milestones and the profit and loss is a measure of the progress or profitability. If you get the balance sheet wrong so will your profit and loss projection be inaccurate.

I recommend that businesses start by looking at the balance sheet. Then ask if the figures for the various assets and liabilities look reasonable and reliable.  If they’re reasonable then the profit and loss are also likely to be reliable.

Checking your balance sheet

So, how do we check the balance sheet?

One way is by comparing the sheet to the records that the bank has. This could be by reviewing your bank statements and being sure that you understand any emerging differences. The only difference we should have is timing differences ie. if we pay a cheque but it’s not yet processed at the bank. Accountants call this checking process ‘bank reconciliation’. Therefore, what you’re doing is simply proving your records are correct by comparing them to another source.

We should also look at customer balances. I find that most business owners are very much on top of who owes them money. If I give them a list of customer balances with something wrong then they’ll quickly tell me. So check your customer balances, look for anything inaccurate. If you find any, correct them immediately. Remember, if a customer balance is wrong then your sales figure could also be wrong.

Let’s move on to the supplier balances. Again, most business owners are aware of who they owe money to and thus will quickly spot any error. Again, if supplier balances are wrong, then your purchased costs could also be wrong.

Your inventory or stock number is a key figure in your accounts.  If your inventory is overstated, this has the effect of making it look as if you got stock for free. In consequence, your profit will be overstated.  If your inventory is understated, then it looks as if you lost stock somewhere so your profits will be understated.   It is very important to get your inventory or stock number right.

Finally, we can quickly look at the other assets and liabilities that might be on the balance sheet. Check if they look ok. For example, if there’s machinery or equipment listed in your assets, do the balances look ok? If there are tax liabilities, do those amounts seem right?

Once you are convinced that your balance sheet is reliable, then you can rely on the related profit and loss account.

Getting your head around shareholder funds

There’s one section of the balance sheet that sometimes confuses clients. This is the section called ‘shareholder funds’ or sometimes called ‘owners equity/capital’. In essence, this section represents the value of the business to the owner.

To understand shareholder funds, you need to ask the question, ‘If the business makes money, who does that money belong to?’ The answer is that it belongs to the owners.

So the difference between what the business has (the assets) and what it owes (the liabilities) represents the value of the business. We call it shareholder funds (or owners’ equity) for companies or owners’ capital for non-company businesses.

Shareholder funds are reduced by money taken out of the business such as dividends or drawings.  So the difference between any two balance sheets represents the profits made by the business in the period.

Check your reports regularly

Your reports are a real goldmine of information. So I recommend to my clients that they get into a routine of regularly – at least monthly – reviewing and checking their reports. By doing so, you learn as much as possible about the business and can quickly identify where action may need to be taken.

If you are familiar with the ‘Lean thinking’ approach to business, you may have heard about the three voices.

  1. The first voice is the voice of the customer, giving feedback on the quality of the service your business is supplying to them.
  2. The second voice is the voice of the people working in the business. They see up close what’s actually happening and are often an untapped source of information regarding how well the business is operating.
  3. The final voice is the voice of the process. We access the voice of the process by identifying the key measurements that let us know how the process is doing.

You should always look at your accounts as a voice of the process. A well designed and implemented account will provide extremely valuable information about the performance of the business. Therefore, rather than thinking of accounts as a compliance-type chore, think of it as a hidden hub with rich information. So try to find out how best you can access it.

Getting in control of your business performance

When you understand your accounting basics, the value of good reporting, and the insights provided by your business numbers, you’re in real control of your enterprise.

And when you add the benefit of working with an experienced, process-driven accountant, you’ll soon start to see the positive changes and improvements in your sales, cash flow, and the profitability of your business.

If you’d like to know more about working with AccountsPLUS, and applying our ‘engineer’s perspective’ to your accounts, please do get in contact. We’d love to help you get complete control over your finances and business performance.

Get in touch to arrange a meeting with the AccountsPLUS team 

managing your business finances

I have provided part-time controller services to many businesses over the years. The level of financial management in businesses varies from business to business. There are a number of broad categories that could help in managing your business finances.

No Financial Management

The least capable of businesses ignore financial management. Documentation is gathered up during the year and given to the year-end accountant in order to prepare annual accounts and tax returns.

In this scenario, the management effectively runs the business with reference to the bank statements. In addition to that, you have no financial systems, paper, or computerised workflow; and you often pay VAT and PAYE estimates during the year and balance them up at year-end.

The problem with such a scenario is that you get lots of surprises.  Unfortunately, you will not know how you are doing until your external accountant does your accounts at year-end.  You end up being constantly blindsided even when you could be losing a lot of money.  Furthermore, you are likely to get caught with bills that you were not expecting. Surely, living in this sort of environment is soo stressful.  You would probably find it hard to sleep at night.

I would advise you to start by getting you to put in some systems, preferably computerised. It would capture basic information on sales, purchases, cash in and out.  You will know at any point how much you sold, how much you bought, who owes you money, who you owe money to, and you would know how much VAT and PAYE are owing.

Business Finance Management

Basic Financial Management

The next group is companies that have a book-keeper, either internally or outsourced. They have some sort of book-keeping system – most likely computerised but it could also be paper-based.

These companies record purchases, sales, and cash transactions. You process payroll during the year and prepare and submit their own VAT returns.

Usually, the only accounts that you get are the annual accounts from the accountant.  You will have some idea of how you are doing as you will be able to get sales reports and some cost reports during the year. Your business is likely to get surprises when you receive the year-end accounts.

I started referring to this level of financial management as “No Offences” as they comply with the legal requirements only.

The problem here is that you have little or no visibility as to why you are getting the results you are getting.  You are making decisions based on instinct rather than facts.

I would advise you to put in place a monthly routine so that you first check that the numbers in the system are reliable. I would set up a process to identify any adjustments that are needed to get accurate profit figures.  Also, I would identify key reports and have your bookkeeper start to give you a monthly financial reporting pack.

I refer to this level of financial management as “No Offences” as they comply with the legal requirements only.

Business Finance Management

Integrated Financial Management

As we go further up the capability ladder, your business will have either internal or outsourced resources that will prepare management accounts for you. They usually analyse sales and costs so as to get some meaningful information. They may do stocktakes during the year or, if not doing a full stock take, they will generate an informed estimate of the stock levels.

If this is your business you will usually have computerised financial systems but these may not be integrated with operations systems.
You usually prepare an annual budget and, in the management accounts, actual results are compared to budget figures. You will be investigating differences. In this way, you are building up your understanding of how your business work and what affects the profitability and cash flows of the business.

The business will also use that budget to generate costs for their budgets or services.

On a monthly basis, management will review these management accounts and will refer to them when making significant business decisions.

I started referring to this level of financial management as “No Surprises”. They have a reasonable sense of the financial results as they go through the year and when they get the annual accounts, the results tend not to be a surprise.

If I was advising you, I would be double-checking that you are focusing on the key performance measures. Secondly, I would be focused on understanding why your results are varying from what you expected.  Thirdly, I would be drilling down into the numbers to know how profitable each product is. In addition to that, I would also be looking ahead to see what is happening with cash and to make sure that we don’t hit any problems.

Business Finance Management

Strategic Financial Management

The highest level of financial management capability that I come across is what I call Strategic Financial Management. In this scenario, your business will regularly prepare a long-range business plan which will include financial projections. The financial projections will comprise profit and loss, balance sheet, and cash flows.

If this is your business, you will usually have a full time or part-time financial controller who will provide financial inputs, interpretation, and analysis to the management team. The financial controller also provides guidance and direction to the accounting staff.

The projected financial statements will be consistent with each other. It will allow for sensitivity analysis ie testing what might happen to profit and cash if a key input varies.

The projections will be updated regularly – at least annually, but often quarterly or every four months.

These businesses can anticipate cash squeezes, funding needs, and will take action to address these before they cause problems for the business. They also know which products or services are generating profits and which are not.

Furthermore, they usually have financial systems that are integrated with the Operations systems so that they have very good insights into how operations are driving the financial results.

I refer to these businesses as “No Regrets”.  You know that you have a good business. You make every effort to ensure that the business achieves it’s potential. In years to come, when you look back, you can feel confident that you gave it your best shot and you have “no regrets”.

If I was advising you, I would be making sure that you keep doing what you have been doing. Look for further improvement – better analysis, faster reporting, reducing the work involved to get the information.  I would expect to be spending more time with you looking ahead – evaluating opportunities and assessing the impact on the profitability of any changes that are coming.

Over to you?

Where do you think you fit into this classification?

Are your financial results different from what you expected? Click here to find out why.

Do you want to improve your financial management or need further assistance? Feel free to call me or drop me an email. With a small bit of information about your business, I will be able to assess the level where you are, identify some improvements, and help you implement these.

using-accounts-to-manage-business

Hello,

Do you ever wonder how some businesses are able to use their accounts to help them manage and improve profitability?  In this short video, I will give you an approach that will change how you think about, and how to use accounts to manage a business.

I’m Jim Cahill of AccountsPLUS. I provide CFO/FD services to Engineering and Construction companies.

PDSA

You may have heard of the idea of a feedback loop, sometimes called the engineers’ feedback loop. In Lean and Business Improvement Circles it’s called PDSA which gives a better idea of what it’s about. PDSA stands for Plan Do Study Act.

When using PDSA you start by making a plan for what you want to achieve – that’s the P. Then you carry out the plan by doing something – that’s the D. On completion of your work, you study what happened – that’s the S. In studying you want to find out if you got the results you expected and if not why not. Finally, armed with the knowledge that you have gained, you act – the A. You use the information to make changes – either in your plan or in how you are executing the plan. Learn more about PDSA.

So now you can see why it’s a feedback loop and by using this in your business you learn about what’s working and what doesn’t work and you apply that knowledge.

Linking PDSA to Accounts

So how does that tie back to accounts?

At the start of a period, usually a year but it can be some other period, you create a financial plan for the period. This is your P. I have a separate article on planning or budgeting.

Then you operate the business – executing the plan – this is your D.

Next step, you get management accounts – this is the feedback from your business – and you study these. This is the S. I have another article on designing your accounts to get good information.
Were your assumptions correct? Did you get the results you expected? If not, why not? So you develop your understanding of what’s happening in your business.

Finally, you make decisions about what actions, if any, you need to take and you take those actions – your A. I also have an article on carrying out improvement projects.

In order for the above steps to work, you need to have regular and reliable management accounts. These accounts should be designed to provide you with an analysis that will help you analyze your performance.

Conclusion

That’s the sort of work that I do to help clients use accounts to manage business.  This includes identifying what they need from their accounts and putting in place the procedures that will give the information and finally helping them analyze the results and implement the improvement strategies.

If you feel this would be of benefit to you, feel free to contact me by phone at 086 2323525 or email jim@accountsplus.ie.

I hope this was helpful and thanks for watching.

One of the questions that I get asked most often by business owners is how to decide between one or more options – when faced with path A or B, how do you know which fork to choose and what the potential outcome may be?

These sorts of question arise for businesses of all sizes and they’re just as important for the small business owner as for the large business owner. In the past three months, I’ve helped a painter/decorator decide if he should change his van and I’ve helped a large food manufacturer decide whether to outsource production, or keep it in house. For both of them, their decision was important and could have an impact on their business.

The value of good advice

I wasn’t long qualified as an accountant when an old school friend, now a dentist, asked me if he should refurbish his dental surgery. He’d already asked his accountant, who replied “that’s up to you”. That answer wasn’t very helpful. We know it was up to him to decide but his accountant wasn’t providing him with any advice as to how to make that decision.

To put it bluntly, he wasn’t adding much additional value as an accountant.

But (thankfully) times have changed, and most good accountants now realise that a large part of their role it to help with this kind of decision making – whether it’s supplying the right numbers, forecasting the potential outcomes or looking at the strategic implications.

So how do I go about making financial decisions?

I focus on the cash flows in your business and compare the different cash flow relating to all the options.

The simplest way to explain my approach is to imagine that the business has a large barrel of cash and ask what will happen to the cash in each of the scenarios. What money will come in and what money will go out? Once I identify the cash flows, I enter them into a table with three columns.

  • The first column is for the cash flows in the current situation.
  • The third column is for the cash flows in the alternative situation.
  • The middle column is for the difference in cash flow between the two options (I’ll show you an example of a completed table shortly).

Before you do that, you need to decide what sort of a time period you’re going to consider.  Its common to look at a decision over the life of the relevant item – so if it’s a van and you plan on changing again in three years, then you might evaluate it over three years. If you’re looking at outsourcing production, you might just look first at one year and then consider whether you need to review a longer period.

So, let’s look at the van example.

How much will a new van cost?

Let’s say John is currently running an 8-year-old van. His garage has a good 3-year-old van for €12,000 and will give him €1,500 for the old one. John wants to know if he should change.

The first thing I will ask is what the current van is costing him. He tells me his current van works up the following costs:

  • €3,600 a year in diesel to fuel the van.
  • €300 a year to tax and €500 a year to insure it.
  • Repair costs as the van had been giving him trouble which needed repair
  • €100 per day to hire a replacement van while his own was off the road – he expects this to continue and suggests that I allow 5 days a year for being off the road with maintenance work.
  • 2 days a year in lost earnings while he is dealing with the van – where he normally earns €400 per day on average.
  • Overall the van is costing John about €2,000 a year in maintenance, €1,000 of which is normal wear and tear, the other €1,000 is due to breakdowns.

Next, let’s look at the costs of buying a new van:

  • The new van John has his eye on will cost €12,000
  • We can then subtract the €1,500 trade-in on the old van.
  • John reckons he’ll sell the van on in 3 years for €4,000.
  • He estimates that it will cost him about €3,100 a year in diesel.
  • It will cost him €250 a year to tax it but €600 a year to insure it.
  • He’s not expecting to have any breakdown days or van hire.

So, overall the new van should cost about €1,000 a year in maintenance, which is all for normal wear and tear.

Note – these are not real numbers. They’re my best guesses to develop a reasonable example for you.

I put my table together, taking three years into account.

Current Van Difference New Van Comment
Investment 0 -10,500 -10,500 As I’m only looking at what will happen from now, I don’t consider the cost of the current van.
Fuel -10,800 1,500 -9,300 This is fuel cost over 3 years, based on the info supplied.
Maintenance -6,000 3,000 -3,000 Maintenance cost over 3 years. based on the info supplied.
Van Hire -1,500 1,500 0 5 days pa for 3 years at 100 per day
Lost Earnings -2,400 2,400 0 2 days a year for 3 years at 400 per day
Tax -900 150 -750 Info as supplied
Insurance -1,500 -300 -1,800 Info as supplied
Resale Value 0 4,000 4,000 Info as supplied
Net Cash In/(Out) -23,100 1,850 -21,350  

 

Positives in the cash flows are ‘cash in’ and negatives are ‘cash out’. In the difference column, positives show where the new option is better than the current option; i.e. cash in, or less cash out.

So, what the above table tells us is that a new van looks like it will save about €1,850 over the three years. We need to be careful and remember that we’re making assumptions, albeit reasonable ones, about the performance and reliability of the new van. We need to be confident that we are aware of, and considering all of, the costs.

We’re not taking into account intangible elements like the effect on his business profile of driving in a newer van. Also, we’re not taking into account the effect on customers of cancelling work because the van let him down. And we’re also not taking into account the effect of having a reliable van and less stress and worry on John himself. We can allow for those in our decision but it’s hard to quantify them and put them in the table.

The bottom line is that the new van looks like it will save him €1,850 over the three years but there are some intangibles that might also be worth a lot to John and only he can put a value on those. I think most of us would change the van based on the info above.

The time value of money

Another factor to take into account is what accountants call the ‘time value of money’.

If I ask you which would you prefer – €1,000 now or €1,000 in 1 year – you’ll all intuitively know that if I get €1,000 now I could invest it somewhere and maybe make another €10 to €30, say €20, in that year. That means that €1,000 now is really worth €1,020 in 1 year. This is what we call the time value of money.

For some decisions, it can be worth taking this time value of money into account.  If you have high interest rates and two options with very different cash flow patterns then it may be worth looking at. But for most day-to-day investments, it’s not worth the additional work – and in any event it will involve other assumptions.

A systematic approach to decision-making

So, that’s how I recommend that you approach decision-making – by systematically breaking down those cash flows and seeing which scenario works out best for your business.

  • Identify the options available to you.
  • Note down the cash flows for each option.
  • Put them into a table and see which one looks best.

Put a little bit of time into challenging your assumptions and into thinking through the options to make sure you have considered everything that is relevant. And armed with your outputs you can be confident you’re making the best decision for the future.

Next time we’ll look at some more practical examples of how this can be put into practise.

If you’d like any assistance with your business decision-making, please do get in touch to see how we can help