Who AccountsPLUS are NOT a good fit for

I know that AccountsPLUS is not going to be a good fit for everyone.

Over the years, I have worked with many different colleagues and with many different clients.  As I review my experiences, I realise that there are some types of clients who don’t benefit from my approach.  Equally, I get more enjoyment and satisfaction out of working with some clients more than others.

I feel that we offer less value if you fit the following criteria….

You believe that your accounts are a necessary evil

You think that your accounts are just something you have to do for the taxman or the bank or the Companies Registration Office.

How I think

Your accounts should be a voice of your business.

I like to understand, and help the client to understand, why they are getting the results that they are getting.  I believe that your accounts contain useful information which should be analysed to drive understanding and improvements

You believe that you have a straightforward and easy to manage business

There are some businesses where the owner will have a very good understanding of what is going on and will not need accounts information to tell them what they think is obvious.

How I think

I don’t believe that there are many of those types of businesses.  If that is true, then I agree. You do not need the experience and skills that I can bring.

But I also believe that, from time to time, even those businesses hit rocky times and can benefit from external insights and help.

Your main focus is on minimising your tax bill

That is the only thing that counts to you.

How I think

I prefer to focus on the amount of after tax profits that you keep.

You can make 40K in profits and maybe pay 8K in taxes keeping 32K.

Or you could improve your business to make 60K in profit and maybe pay 13K in taxes while keeping 47K.

I would prefer to be in the second case, where I have 15k more of after tax income.

You think your business is already doing as well as it possibly can

You are running a tight business and you know what is going on and why.

Nothing is perfect and there is point in striving for perfection.

You think that you just have to work hard and no accounts will change that.

How I think

I haven’t come across a business that could not be improved in some way.

I am always looking for an improvement opportunity – something that will help increase sales or profits.

You don’t see any benefits in planning

Plans don’t always work out anyway.  There are too many variables at play and planning is essentially sticking your thumb in the air.  You just think “why bother?”

How I think

I like to quote Verne Harnish, who in his book “Scaling Up” says “A fundamental responsibility of leaders is prediction.”  Your accountant can help you see make those predictions by creating planning models that helps you see the effects of events both inside and outside the business..

I also believe that the process of planning and then comparing your actual results to your plans helps develops your understanding of your business.

Preparing plans can provide early warning of upcoming problems that can be avoided by increasing your awareness of what to watch for and by helping you spot indicators that are off

You keep basic records and you don’t like technology

You keep the basic documentation and believe that it’s the accountants job to take those documents, organise them and use them to prepare your accounts.   You believe that the accountant should use his/her software to sort it all out. You don’t want to be worrying about software licenses, updates, hardware or backups.

How I think

There is cheap and easy to use software available now that makes it much easier to organise your information.  My time as an accountant can be better used analysing that information to help clients manage their business.

You are looking for the lowest price accountant

For you, preparing the accounts is a simple job and you want it done as cheaply as possible.  You think you will get the same result from any accountant so why pay more

How I think

I know I am not the cheapest, but I also know that I am far from the most expensive.

We help clients improve profitability by having better information and better management tools.  We help clients save money on taxes through better tax planning.  We give clients peace of mind by improving their overall control of the business.  My clients tell me that the benefits they receive are worth multiple of the fees that they pay.

You don’t see your accountant as part of your management team.

You think of your accountant as an outsider who does a very specific job.  You don’t involve your accountant in any of your management decisions.  The accountant’s job is to summarise it all at the end of the year and do your tax returns.

How I think

One of the key roles of the business owner is to make decisions.  He/she needs quantitative information to make the right calls. Your accountant can provide that information and should be included as a key advisor.

Accounts are something you get done at the last minute

You don’t worry about your accounts until your deadline is approaching.  Then you gather everything and send it off to the accountant. By the time, you get your accounts the period covered is long past and there is nothing you can do about it anyway.

How I think

Your year end accounts should just be a matter of taking the management information that you have and using it to complete your filings.

You should be analysing your information as early as possible so that you time to identify and take appropriate action.

To paraphrase Verne Harnish -” your year-end accounts should confirm what you already know about your business”.  There should be no surprises.

Most Common Problems with Product Costs

I find that one of the most common problems with clients is that they are not confident in the product costs for their products or services.

If the products costs are wrong then their product prices may be incorrect.  They could be too expensive,  losing them business, or possibly they could be losing profits by undercharging.

My first work as an accountant was in manufacturing plants where we used the best product costing methodologies.

Since starting to work as an independent accountant offering part time controller services, I have helped clients in construction, engineering, manufacturing and service develop and improve their costing approaches.

Over the years, I have seen 5 common problems.

The client doesn’t prepare an annual budget

When we are preparing product costs, what we are trying to do is to allocate the total business costs across the product range.

To do that, we need to know what the total product costs for the business will be for whatever period we are working with.

When we finish our costing exercise, the total of all of the product costs that we plan on making should tie back to the total costs we expect to incur.

That is our key check – our key control.

We need to start of with a reliable budget for the year.

To see how I recommend you prepare a budget, you can look at this article on Predicting Business Costs.

How to fix this problem

Best practice for all clients is to prepare an annual budget.

If your business is small, then this will be a fairly easy task.

If your business is larger or more complex, then it’s slightly more difficult but also more important and you really need to do it.   The greater the complexity, the greater the benefits you will get from doing it.

It should be possible to develop a spreadsheet that can be updated from year to year.

The client doesn’t know what is actually being used to make the product

Many clients are not using their accounts for management purposes.   Their accounts exist solely to comply with requirements.

They have a figure for the materials purchased but they don’t always know how much material is used for each different product.

They may have a document which tells what should be used in making the product in a perfect world.   They don’t always have easily accessible information about what is actually happening in the real world.

They need information showing how much of each of the various raw materials are used to make each of their different products.

If they have a controlled product, say a food product, they must keep data for traceability but it may not available to help with management support.

how to fix this problem

Every product should have a bill of materials.  This is essentially a recipe.

What a bill of materials is telling you is not what is in the product but what gets used to make one of the products.

The bill of material should reflect normal waste and normal working practices.  What you want is to identify the average quantities needed for a good production item.

Client ignores waste or scrap

In some cases, the production process is generating waste or scrap but the client was ignoring this.

Let’s say, the client buys in timber to make chairs but the moisture content of some of the timber is too high.  That timber has to be discarded.

However, it may not be possible to send the timber back to get credit.  Maybe the supplier is overseas or maybe the supplier is arguing that the timber was not stored as recommended so the supplier is passing on the responsibility.

In any event, the cost of the unusable timber is a real cost to the manufacturer.

He/she may not be able to pass any or all of that cost on to the customer.  But he/she has a timber cost that they need to be aware of.    At a minimum, they should have an improvement project to try to reduce the losses due to substandard raw material.

Another example could be where the manufacturer has to trim a raw material, let’s say meat, of fat or bone.  The raw material is natural so the amount of trimmings can vary from batch to batch.

We understand that there will always be some trimmings.  What we need to do is identify a reasonable average and use that in our costings.

We should be saying something like “for every 100kg of meat we buy, we use 95kg in the process”.  The cost that we have to bear and pass on to customers is the cost of the 100kg.

how to fix this.

Ideally, you would have a system where raw materials are issued to a batch and at the end of the production period (day, week, month) you can identify the normal usage for each completed item.

If you don’t have that detail, you should still be able to quantify how much  raw materials were used and compare that to what you think should have been used.

The difference will quantify your scrap or waste and you should have programmes in place to reduce this.

Client using inaccurate input costs

When you are preparing costs, you need to have a good handle on what the inputs are costing.

Ideally, you will track the costs of each input and know if they are going up or down and how they compare to historical costs.

In some cases, clients though they know what the inputs were costing but they had not kept up to date with recent changes.

how to fix this

You should either have a product code for each raw material and should track the costs for each order or invoice.

You should have a list of current prices for each of your raw material items.

Client charging for unused production capacity

At the top of this article, we said that we are trying to spread our actual production costs over all of the products that we are producing.

However, if we are a start up and the business is not fully loaded then it may not be sensible to try to pass the costs of our unused manufacturing resources on to our existing customers.

Let’s say, our plant can do 1800 production hours in the year.  But we are only selling 50% of our capacity.

If we are competing with other factories who are working to full capacity, then our costs for our output should be higher than theirs.  However, if we have higher costs and there is no difference in the products, then a sensible customer would buy off the competitor as its cheaper.

We may have to bear the cost of the unused capacity until such time as we can get the sales up to a point where we are using the full capacity.

However, if we have a unique product that has benefits that the competing product does not have, then we may be able to charge more.

That’s an issue we should be aware of and have a proper discussion about internally.

How to fix this

When preparing your budget, you need to be able to express your production output as a percentage of your capacity.  Where there is significant unused capacity, you should be aware of that.

Then you can have the conversation about whether or not you can pass that cost on, or not, to your customers.

Conclusion

These five are the most common costing problems that I have come across.

You should review your own situation and see if any of these are relevant to you.

If you have any comments, you can leave them below.  If you have any questions, please feel free to email me.

 

What does a part-time Financial Controller do?

Thinking about a Part-time Financial Controller?

Have you ever thought about using a part-time Financial Controller?  Would you benefit from having access to additional financial management skills?

I was talking with a business owner recently who is running a substantial, exporting business.  They don’t have any qualified accounting staff in house.

Their annual accountant comes in during the year to prepare quarterly management accounts. He also attends monthly management meetings to provide financial input to business decisions.

The business owner is not satisfied with this arrangement.   He would like to have an internal controller but he knows that he cannot afford that option.

Option of a Part-time Financial Controller

I asked him if he had considered using the services of a part-time financial controller.  He didn’t realise that was possible.

The option of having a part-time controller is quite common now.

There has been a growth, in recent years,  in the number of companies availing of the services of part-time financial controllers.  This is partly due to the rise in the use of computerised accounting systems and also due to the increased awareness of the need for better financial management skills

What does a part-time financial controller do?

Start by understanding the business

The first thing a financial controller (FC) will do on starting an assignment is to understand the business and the needs of the owners/managers.

Typically, the part-time FC will want to get familiar with the products or services, the customers, the production or delivery process, the inputs and the suppliers.

He/she will want to be clear on the goals of the business so that he/she can provide better support.

Create helpful, relevant reports

They will use their understanding of the business to identify what sort of financial analysis is needed for the business.

This could include how sales are analysed, how purchases and overheads are analysed and what cost centres or departments should be used if any.

Usually, the FC will have an input into the development of Key Perfromance Indicators (KPIs) for the business although the KPIs should not be just financial (see article on KPIs here).-

Optimise the financial processes

Next, they will look at the work flows within the department identifying who does what ,what controls are in place to secure the companies assets and if they have appropriate systems and if they are using those systems well.

They will also want to ensure that the activities required to support the business and to produce the  financial reports are clearly identified and allocated to staff with appropriate skills and experience.

Assess and Develop existing staff

At some point, the FC will review the existing staffing of the department and form an opinion on how much support and/or development they might need.

The staff will look to the FC for technical guidance.

Prepare Budgets/Forecasts

The FC will usually prepare an annual financial budget for the business.  This will be based on assumptions about growth, staffing, costs and investment plans.

The budget will show how profitable the plans of the business are and will highlight any problems with cashflow.

Depending on the business, this budget may have to be updated 2-3 times during the year to reflect developments that are emerging as they work through the year.

The budgets will feed into the monthly management accounts.  By comparing actuals to budget the management will develop their understanding of the business and will become much better at budgeting.

Preparation of Management Accounts

The activities that I have already talked about are all necessary if you want to have high quality management accounts.

This is where most of the FC’s time will be spent.  The FC will pull together draft accounts and check them to make sure they are reliable.

The management accounts will show if the plans of the business are on track.

By drilling down into these accounts the FC will develop his/her understanding of what is going on in the business.

Cash Management

Most businesses need to manage their cash closely.  Even when a business has large cash reserves, you find that they have built these up by managing cash closely and that they continue to do that.

The FC will develop short and long-term cash forecasting and management procedures and will provide guidance for the staff in how to work with these.

Providing Financial Inputs to Decision Making

As the business is carried on, issues crop up that will require decisions and the FC can provide key financial inputs to those decisions.

These decision may be about pricing or investment decisions.  They can be about adding or discontinuing product lines.  Every business has to make decisions and these decision usually benefit from a financial input.

The FC will draw on his/her understanding of the business and on the reliable accounting information that is being prepared under his/her guidance.

The FC will have to support management by explaining the decisions using excellent communication skills.

Adding Experience to the business

Usually a part-time controller has already held a full-time controller position and can bring that experience to their clients.

Additionally, because most part-time financial controllers have many clients they will be exposed to lots of different businesses.   They can take the best ideas and practices from one sector to another.

In this way, the part time FC can help the client adopt best practices from sectors that they may not normally be exposed to.

What skill sets does a part-time FC need?

Firstly, the FC will need to be able to develop a good understanding of the business.   He/she will need excellent commercial awareness.

It would be expected that a part-time FC would have good accountancy skills.

He/she will have to have good relationships with the management and staff and will require to be able to communicate accounting information in a way that is easily understood by a non-accountant.

The FC will likely have a number of different clients and will need to be able to manage time.  They should also be able to easily switch between clients without having to spend a lot of time catching up.

How much time will an FC need to input

That depends on the business – both on its complexity and on its stage in the business life cycle.

A young ambitious business with challenging growth plans will need more time than a mature stable business.

It will also depend on the quality of the in-house accounts staff.  The more you can delegate to them, the less time the FC will have to input.

For some businesses, the time input can be as little as a half day per quarter.  For others, it can be as high as 2 to 3 days per week.

Typically, I find 1-2 days per month the most common.

Normally, the part-time FC will sit with the client and understand the clients business and needs.  They then discuss they different elements of the service and can allow the client to customise the service to suit what they need.

What businesses need a part- time accountant?

If you are having any of the following problems, then you should consider hiring a part-time FC.

  • Disappointing profitability
  • Cashflow problems
  • Accounting surprises at year end
  • Having problems explaining the performance of your business to your bank managers
  • Having aggressive growth plans that require tight financial management
  • Thinking about bringing external investors on board
  • Not satisfied with the explanations that you are getting from your annual accountant

Why do you need more than one accountant?

Sometimes businesses ask why they need another accountant when they already have an annual accountant.

You don’t have to have more than one accountant, but sometime different people have different skillsets.  You may be better off having 2 or more people with specific skills rather than one generalist.

If your annual accountant can give you the financial analysis and insights that you need then that is fine.  You don’t need someone else.  However, if you are not getting information and explanations from your annual accountant, then you may  want to get those insights from someone else.

Some business owners like to have one accountant who provides part-time controller services and also does the compliance work.  Other owners like to have the year end work done separately.  It doesn’t matter and its pretty much a subjective decision for the business owner.

Management Accounts v Annual Accounts

The focus of a controller is usually on delivering management information.  This will help management understand the financial effects of their decisions.

The focus of the annual accountant is usually on compliance.  By compliance we mean preparing the annual accounts and the annual return and the tax returns.

Conclusion

Running a business can be demanding.  However, there are resources available to modern owner managers that were not available prior to this.

Having the services of a part-time controller available lets the business owner have access to better information and analysis skills at a fraction of the cost of a full time controller.

Over to you

Have you had experience of working with a part-time financial controller?  Was it beneficial.

Have you any comments or advice to offer to others.  Feel free to leave a message in the comment sections.

What is a VIES Return?


Over the past year, I have been getting questions from clients about VIES. Typically, the client has received a letter from Revenue advising them that they should be submitting a VIES Return. But the clients typically don’t know what VIES is and have no idea how to make a VIES return.

At this stage, I have significant experience with VIES. Having worked with larger companies in the past I was very familiar with filing VIES returns. More recently, a lot of my current SME clients have asked for help with the VIES filing.

What is VIES

VIES is an abbreviation for VAT information Exchange System. It is an EU system and applies to any business that sells to other EU states.

Where a supplier sells goods or services to another EU country they can apply the zero rate to the supply of goods or service. In order to ensure that this zero rating is not abused the supplier must make reports showing the VAT number of the customer and the value of supplies.

This information is shared between EU tax authorities and the relevant authorities can make checks to ensure the zero rate was correctly applied.

What to do if you are selling to a customer in another EU State

If you sell to a VAT Registered customer in another EU state, you do not have to charge VAT if certain conditions are met.

Verify that your Intra EU EU Customer is VAT Registered

An intra EU sale is a sale from one EU country to a customer in another EU Country so its within the EU.

Where you are selling to a customer in another EU State, you must first verify if that customer is VAT registered.

To do that you go to a website and enter the customers VAT number. The website is this one http://ec.europa.eu/taxation_customs/vies/.

You enter the customer VAT number and country and your own VAT number and country.

You will receive a message to let you know if the customer VAT number is valid or not. If it is valid, the message will include a reference number which you should keep as proof that you performed the check.

Once you have confirmed that the customer’s VAT number is valid, you can apply zero rate VAT to the customer.

Other Conditions

There are some conditions for this to be applied correctly.
• Your invoice should include the customers VAT number and your own VAT number.
• Your invoice should state that reverse charge VAT is being applied.

Showing EU Sales on your VAT3

When completing your VAT3 return, there are some question to be answered.

These ask if you have sales of goods to other EU countries or sales of services to other EU countries or purchases of goods from other EU countries or purchases of supplies from other EU countries.

If you answered yes to the questions about sales of goods or supplies then you have to file a VIES return.

Typically, if you get the letter from Revenue asking you to submit a VIES return, it means that you ticked the box saying that you had sales of goods or services to other EU Countries but you haven’t submitted a VIES return.

How to file a VIES Return

The easiest way to file a VIES return is using ROS.

Firstly gather a list of your sales to customers in other EU countries.

Identify the VAT number for each country and the total value of Sales for each customer.

If your accounting system supports it, you should record your customers VAT number on the system to make it easier to access it. You may be able to generate a VAT report that will show you the VAT numbers and value for all sales to other EU Countries.

Then, login into ROS and select complete a return online.

From there, chose tax type as VIES and chose the appropriate period.

Smaller business file VIES less frequently.

What is on a VIES return.

The VIES return lists the VAT numbers for all of your customers in other EU countries for the period of the return and shows the value of goods or services sold to that customer in that period.

What do the Authorities do with the VIES information

This information allows the tax authorities in the other states to check that the company exists and that they were entitled to be invoiced at the zero rate.

They can also check if your customer correctly accounted for VAT on the reverse charge basis.

Using Reverse charge, the customer should include a notional sale on their VAT return creating a liability for VAT and at the same time they claim notional VAT on the purchase from you.

As the VAT on the notional sale is the same as the notional VAT on the purchase from you, they don’t actually owe any VAT. However, they are showing that they did have an intra EU purchase.

In the past, some sellers would sell VAT free to a non-business customer from another EU State but entering an incorrect VAT number. Sometimes customers would supply the VAT number of a legitimate business who did not know that their VAT number was being used in this way.  In this way the non-registered customer avoided the cost of VAT.

With VIES, the VAT authorities are able to check if the seller applied VAT correctly.

The seller should have a valid VAT number for the customer and should be able to show that they checked the validity of each VAT number. If they can’t they they will be liable for the VAT.

Conclusion

For suppliers who have complied with all the requirements, filing a VIES is pretty straightforward. You just need to make sure that you have verified the VAT numbers and can show that you did that. If you have a lot of sales to other EU businesses, it would simplify reporting if your system allows you to create the report.
If you have only a few sales, then it should be easy to pull out the customer VAT numbers and Total Values.

Over to you

If you have any comments or questions on this, feel free to let me know. The best way to do that is to send me an email.

 

Managing Foreign Exchange – Preparing for Brexit

In the past few months, I have been getting more and more questions from exporting companies who are worried about the effects of Brexit on their businesses.

There are a number of areas that cause concern but two in particular are common for the companies I have been talking to.

Firstly, Sterling has weakened significantly since the Brexit vote.  That will either make Irish exports more expensive for UK customers or else will reduce the profit margin on the transactions for the Irish seller.

Secondly, the introduction of customs controls could cause delays at the points of entry into the UK resulting in delays in receiving payment or in deterioration in quality of perishable products.

In this article, I am going to talk about the issue of managing foreign exchange.

Back in my early years in employment, I worked for a large multi-national computer manufacturer and for a number of years I managed the treasury section which dealt with large foreign exchange transactions.

My employer provided me with one weeks intensive training to become expert in that area.  So I have some experience in that area.

It’s a little bit different for Irish SMEs, than for multinationals, in that their transactions are smaller and the don’t have the specialist skills or often the time to devote to what could be a very significant element of the business.

You might say that Sterling was never part of the Euro Zone so what’s different  now.  However, it is anticipated that there will be greater volatility in exchange rates in the future with Sterling expected to weaken and a weak sterling causes problems for Irish exporters.

However, there are a number of simple things that can be done.

Foreign Exchange – understanding the jargon

There are a few key phrases that you need to understand.

Transaction Risk

As a business you will be entering into transactions in foreign currency.  The Euro value of those transactions can vary betForween the time you entered into the transaction and the time you pay or get paid from the transaction.

Transaction risk relates to those possible exchange rate movements between contracting and completion.

For example, let’s say that you  agree to sell goods for Stg 50K when sterling is 1.125 =so at that point the sterling is worth € 56.250.  However, the sterling-euro rate is moving so if it takes 2 months to receive payment that sterling could have a different euro value.

For example, last August 50K of sterling was worth €54K while on 24 Jan it was worth 57.4K.  That’s a swing of €3.4K and, depending on the  size or profitability of your business, similar movements could have a big impact on your P&L.

Translation Risk

If you have assets or liabilities denominated in foreign currency then you have a translation risk.  These assets could be physical assets or investments.  The liabilities can be loans.

Translation risk arises as the value of these assets or liabilities in euro can vary with the exchange rate from one date to another.  The risk is that whenever you convert them back to Euro the Euro value could be significantly different to when you acquired the asset or liability.

In my experience, translation risks are not significant for most SMEs.

Hedging

At its simplest, hedging is taking action, usually by entering into financial contracts, to protect your business against currency movements and to protect the underlying profit margins of your business.

The decision on whether or not to hedge depends on a number of factors

  • Your attitude to risk
  • The level of certainty you have about your contracts
  • Time – how long are your typical payment cycles
  • The level of profitability in your business
  • Economic Risk

Understand your attitude to FX Risk

The first thing you need to do is to decide on what level of risk you are willing to carry.

To do that you will need to have a good understanding of your business.  How much foreign currency are you receiving in any period and how much will you be paying out?  How much foreign currency will you be holding at any point in time?

You need to understand the effect on your business that currency movements can have.  You should try to quantify how much your profit would change for each 1% in currency movement.

This is not an exact science.  You may not be able to make exact predictions for your sales but you should use your experience to make informed estimates.

You will not have full control over payment cycles but you will have a history to give you guidance.

Once you have an understanding of your business, you will be able to say how much foreign currency you are comfortable holding knowing that its value can move.

Typically, I get clients to prepare schedules of receipts and payments for each currency.  The time horizon for these depends on your ability to forecast with reasonable accuracy.

Anything greater than the amount of exposure you are comfortable with should be hedged.

Tools for Hedging

Foreign Currency Netting

If you have both receipts and payments in a foreign currency then they will cancel out to a degree and that netting provides you with a natural hedge.

A natural hedge is the reduction in risk that comes from the business’ normal way of working.

If we go back to the forecast of foreign currency receipts and payments mentioned above, you should net off the receipts against the payments leaving you with a net foreign currency exposure.

That is the amount that you have to manage.  The natural hedging looks after the offsetting receipts and payments.

Where you are netting of foreign currency inflows and outflow, you should consider using holding accounts for each foreign currency.  You will deal with the surplus/deficit using the other tools that you have.

If you have sales in Sterling, then you can create natural hedges by sourcing some of your expenses in Sterling.

Another action you could take to create a natural hedge would be to invoice in Euros.  This will eliminate the foreign exchange risk but create a different risk in that you have pushed the Foreign Exchange risk over onto your customer who could either push back on price or move to other suppliers who are happy to take the foreign exchange risk.

Even if your supplier is Irish, if they have costs are in Sterling it may suit them to invoice you in Sterling so that they can create their own natural hedge.

A useful tip for when you are calculating your exposures is to run a number of calculations of the euro value of the foreign currency using different exchange rates so that you better understand the impact of the exchange rates.

Spot Rates

Spot rate is the rate for immediate settlement of a foreign exchange conversion.  It is based on the supply and demand for the currencies at the time of the quote.  As a result, spot rates change frequently and sometimes dramatically.

If I receive 10k sterling today and I ask my bank to convert it today, the rate they will give me is the spot rate.

When you are dealing in spot rates, you have no certainty.  The rate you get will be the rate offered by the market when you are dealing.  You have no protection over your business margins.

If the rate happens to be favourable, you gain.  If the rate happens to be unfavourable, you lose.

Additionally, you have no commitments.  You have not entered a contract, in advance of the deal, to buy/sell foreign currency so you will not incur penalties if something happens and you cannot make the deal.  For example, the customer may be late in paying you or you find that you can use your foreign currency for some other purpose, say buying an asset or materials.

If you are comfortable with the risks and you have appropriate cash flow, it may be better to opt for spot rates and to be able to pick and choose when your convert your foreign currency.

Forward Contracts

A forward contract is an agreement to exchange currencies for a fixed exchange rate on a fixed date or sometimes within a fixed date range.  The rate used is called the forward rate.

Traders calculate the Forward rates by taking the current or spot rate and adjusting for the difference in the interest rates between the two currencies.

If I know that I will receive Stg 100K in 3 months’ time.  I can go to an FX trader and agree a forward rate.  In three month’s time, I will pay over the Stg 100k and receive an agreed amount of euros.

The way the forward rate is calculated it to treat the transaction as if I borrow Stg 100K now and repay it in three months when I receive my customer payments.   When I repay it I will be repaying the Stg 100K borrowed plus interest over the three months.

The Stg 100K I borrow now is assumed to be converted to Euros and put on deposit for three months.

Then in three months’ time, I will have the initial euro deposit plus three months of deposit interest.

The forward rate is calculated by taking the Sterling repayment in three months and dividing it by the euro deposit value in three months.

Effectively, this calculation is taking today’s rate and adjusting for the difference on interest rates between the currencies.

The forward rate is not a prediction of what the exchange rate will be in three months.

It cannot take into account unknown events that might influence the exchange rate such as a war breaking out somewhere, the USA imposing trade tariffs or indeed a country voting to leave the EU

Forward contracts provide certainty about the rate that you will receive and effectively firm up your profit margin.

You will not be able to benefit if the rate moves more favourably than the forward contract.

It’s a contract so you are obliged to honour it.  If you cancel it, you will pay a penalty which will equal the cost to the trader of having to make other arrangements.

FX Options

An FX option is like an insurance policy.  With an FX Option, you buy the right, without any obligation, to exchange a currency at an agreed future date at an agreed rate.

You pay a premium for the FX option.

You do not have to exercise the option – there is no obligation to do so.  Therefore, if the exchange rate is unfavourable on the future date, you can ignore the option but if the exchange rate is favourable you can choose to exercise the option.

The FX Option costs a premium.  You should factor that into the exchange rate to understand what percentage of your euros will go to pay the premium.

However, while fx options can be expensive they do provide certainty.

Foreign Exchange Management Policy

Now, having read down this far, you understand the risks.

You have learned how to quantify them by preparing the foreign currency projections for receipts and payments.

And you understand hedging and the basic tools for hedging.

Lets now look at what should be in a Foreign Exchange Management Policy.

There are four elements

1. Understand your FX Exposures

The first step in managing currency risk is to understand and quantify the actual and potential exposures that your business has.

This involves reviewing both your costs (both raw materials and overheads) and your revenues and preparing a schedule to establish your net exposure for each currency that you trade in.

2. Determine your Attitude to Risk

As a business you should agree and document your attitude to risk.

This means that you and your fellow directors, if any, should decide how much foreign exchange exposure you are willing to tolerate.

You may say that I can hold up to Stg 100K and bear the risk of that moving . Or it could be Stg 500K or Stg M or any other sterling amount.

Alternatively, you could say, my profit margins are so tight, that I cannot take any risk.

Whatever, the circumstances, you decide how much or how little risk you can take.

Make a decision on that and review it regularly – quarterly or annually.

3. Allocate Ownership, roles and Responsibilities

You need to decide who will do what and when.

Who will decide on the attitude to risk level?

Who will prepare the foreign exchange projections ie quantify the foreign exchange exposures?

Who will make the decisions on what hedging to do, if any?

Who will execute the agreed hedging decisions?

Document and approve those decisions and make sure they are communicated to the relevant personnel.

Depending on the size of the organisation, you may want to get board approval for the Policy.

If its an owner manager business, then this step is usually unnecessary.

4. Execute and Review the Policy

Once you have decided on the policy, put it into effect but always keep it under review.

Both external and internal circumstances can change.

Your profitability can improve or deteriorate, changing your appetite for risk.   You could win other business in local currency reducing the significance of your foreign currency business.  Competitors could enter the market forcing you to take more risks.

The possibilities are many so you need to keep it under review

Understand that you cannot totally eliminate risk

No matter what you do to minimise the risk, the currency could still move in such a way that you would have been better if you hadn’t done anything.

For example, if I decide to eliminate risk by entering into a forward contract to sell Stg 100K at 1.13.  I am happy if the exchange rate when the contract matures is higher than 1.13.  But if it is lower I lose.

So you have to understand the effect on your business of the various movement possibilities and accept that by eliminating a possible downside you are also eliminating a possible upside.

It really all about protecting the business.

Conclusion

The key elements of managing foreign exchange are to

  • understand your business and how its affected by FX movements.
  • Understand your own attitude to risk
  • Decide on how you will respond to the various possible scenarios
  • Follow through by implementing the policy as your carry out your business.

Over to you

This is a quick overview of foreign exchange for SMEs.  If you have any questions feel free to contact me by email.

If you are unsure how to prepare projections for your business, you may find my article on How to Prepare Financial Projections useful.

What KPIs should I use?

A question that I regularly get asked by business owners is “what KPIs should I use?”.  Most business owners are familiar with the idea of KPIs and they understand that they should have them but they are not sure where to start.

I have been working in management for over 20 years now – initially as an employee and in recent years as a business advisor.

My focus is on helping business owners improve their profits.  I have worked on many lean projects both as leader and as team member.  I am an approved Lean Advisor for Enterprise Ireland and have helped many SMEs implement Lean initiatives.

In almost all of those improvement projects, I  helped the business owners to select their KPIs.

Let me tell you how I approach this task.

What are KPIs?

KPI stands for Key Performance Indicators. They are quantifiable measurements, agreed upfront, that monitor the critical success factors for a business.

A well-managed business will have a clear vision of where it wants to be in the future.  Critical Success Factors are the building blocks that will enable the business to realise its vision.

The KPIs are those measures which provide feedback on whether or not the CSFs are being achieved.

For example, a business decides that it needs new products to satisfy market needs. Possible KPIs could be number of new products launched in a period or proportion of revenue generated from new products.

It is important to understand the difference between CSFs and KPIs.  The CSFs tell you what must be done for the business to be successful.  The KPIs tell you if those CSFs are being achieved.

I tend to think of KPIs as success criteria.  If I ask you how you will know if something is successful, you will tell me what needs to be checked to find the answer.  The KPIs provide evidence of success or lack of success.

Why are KPIs important?

We are all familiar with the phrase “what gets measured, gets done”.   Measuring something puts focus on it and gives you an objective way of determining if progress is being made.

KPIs are a key part of the visioning process.  If you don’t measure your KPIs, then you are less likely to realise your vision.  They provide focus and direction.

Using a phrase from the Lean Approach, KPIs are a voice of the business processes – they are the feedback from the processes.  They can be used to compare and assess your business, your processes and the performance of your team.

I think of them as the Vital Signs of your business.   They provide an early warning system for your business.  Many people refer to them as the components of the dashboard for your business.

What characteristics should KPIs have?

KPIs should cover Key Business Areas

Your KPIs need to cover the key business elements of Marketing, Operations, Innovation, Human Resources and Finance.  Some of these can be difficult to measure.  It is not always easy to measure innovation or culture

KPIs should be Measurable

We need to have hard data. We prefer not to have to rely on subjectivity or individual assessments.  It must be possible to quantify the things that we are measuring.

KPIs should be Visual

We want to be able to represent the results graphically.   If we can graph something we can see it.

KPIs should be Easy to Understand

Everyone involved in the business should be able to understand what we are measuring and why. To achieve that we must keep things simple.

Applying Two Perspectives to KPIs

I find it useful to think of KPIs as coming from two different perspectives.

From the definition above, you may be tempted to focus on improvement and development initiatives.  That’s fine.  These initiatives are likely to be key building blocks for getting to where you want to get to.

However, you must also take care of the day to day business.  If you don’t maintain profitability, you may not survive to reach your desired destination.

For that reason, I encourage clients to think in terms of Maintenance KPIs and Development KPIs.

Using Process Thinking for KPIs

When selecting KPIs its very useful to think in terms of processes.  In doing that, simple process maps can be very helpful.

Begin by identifying the starting position.  Then you move on to identify the key activities or operations that must be completed to bring you to your destination, the finishing position.

Some people just focus on the end point – the result.  If you have a project or process that will take time to complete, then you should be looking at interim measures that will let you know if you are on track.

Think in terms of predictor measures as well as result measures.  For example, lets assume that you sell a complex product and you know from experience that 20% of prospects will ask for a quote and of those quotes 25% will result in actual sales.

Let’s say that the product sells for 100K and you need to sell 20 this year.  We can deduce that we need to generate 80 quotes to make 20 sales.  We also know that we need to be talking with 400 prospects to achieve 80 quotes ie 20% of prospects.

You should consider having a KPI for the number of prospects identified and another for the number of quotes generated.  The number of prospects identified should be a good predictor of your sales.

Cascading KPIs

Most people accept that the average person can only focus on seven plus or minus two items at any point in time.   Practically this means that our set of KPIs will ideally number 7 +/- 2 ie 5 to 9.

For a total business then we should identify the 5-9 KPIs that will provide a good test of whether or not the business is on track to realise its vision.

However, we can also chunk that down to departments or processes and we can identify 5-9 KPIs for each department or process.

In a management team then we will have 5-9 overall KPIs.  But each member of the management team should have 5-9 KPIs for the areas that they are responsible for.

We can cascade this all the way down to the lowest level process and have KPIs for each process.  We should end up with KPIs for the overall business supported by KPIs for each department and for each critical development process and these will in turn be supported by fundamental processes.

Putting it into action – selecting KPIs

So we have had enough theory, lets see how that could work in practice.

Step 1 – agree the Vision

Firstly, I ask clients to create a vision of where they want to get to.  For every business this is different. It may involve products or markets or profitability or use of technology.

I challenge them to create a picture that will represent where they want to get to.

Step 2 – identify the building blocks

Once we know where they want to get to, I ask them to identify the building blocks.  What has to happen first for them to achieve their vision.

Step 3 – Project Plan for each building block

For each of the  building blocks, I want them to create a simple project plan – what has to happen, who is responsible for that and when must it be complete.

This project plan will provide me with KPI candidates.

Step 4 – Identify Key Ongoing business Processes

Additionally, I ask them to identify the key processes in their business.

This usually includes a marketing process, a sales process, a production or operations process, finance processes and other admin processes.

Step 5 – Identify key monitoring points for ongoing processes

I ask them to map out the processes and identify the key measurement points in each process.  We don’t want to just wait for the finish point – we want to be able to test within the process to ensure that each process is on track to deliver.

Step 6 – Prioritise your KPIs

You are likely to have come up with a list of many KPIs.  You now need to prioritise these so that you can identify a small number (5-9) of driver KPIs.

Ask yourself which of the candidate KPIs are most likely to help you  get the business to where you want it to go.

Step 7 – Document and Assign Responsibility

Once you have your KPIs identified you should document them.

What are you measuring?  Who will measure?  What exactly will be measured? How will they be measured?  Where will the results be posted?  Who will keep the measurements updated?

There should be no ambiguity.   If a key employee is hit by the proverbial bus, then there should be clear guidance available for someone else to step in and keep the KPI measurements up to date.

Step 8 – Measure and Publish

Publishing the KPIs is very important.  This makes the priorities of the business very clear to everyone. In traditional businesses, the measures – often in graphical format – will be posted on a white board in a location where everyone will be able to see.

In newer businesses, they can be published electronically – possibly by email, on a shared folder, on an internal website.  Sometimes businesses will run a powerpoint on a tv or monitor in an area where everyone can see them.

 

Updating KPIs

Once you work through and identify your KPIs, don’t assume that they will not change.

Every so often, you should be updating your business vision.  When that happens you are likely to identify new CSFs and in turn you will have to identify new KPIs.

There tends to be more consistency about the maintenance KPIs.  But even there, if a business is going through a wobbly patch, they may want to edit the KPIs to prioritise something new.

Say for example, that you have found a problem with incoming raw materials in recent weeks.  You may decide to test incoming quality for a while until the incoming quality is restored to the standard that you expect.

The incoming quality test could be added to the list of KPIs until you are satisfied that the problem has been permanently resolved.

Linking KPIs to your accounts

If you want to use your accounts strategically, then you should organise your accounts so that, where possible, information regarding KPIs is highlighted and readily available.

For example, a professional services client told me that he had set a goal of increasing his retainer fee income to being 50% of his total fee income.   A KPI for him then should be the percentage of fee income revenue over total revenue.

At that point, he was not distinguishing his retainer fee income from other income.  However, his accounting systems were well capable of doing that.  So, we created some new fee categories for him.

Now when he runs his profit and loss, his fee income is already analysed by the various categories and he doesn’t to do any further work to get his key meaurement.

By making the KPIs so visible it really emphasised it and he reached his 50% target much faster than he expected to.

Linking KPIs to Improvement Projects

With well-selected KPIs you have put in place a mechanism to let you know when you are not meeting your targets.

Once you know that you are not meeting a target – either maintenance or development – you know you need to improve.

The KPIs are identifying an improvement opportunity for you.  You should immediately initiate an improvement project to bring the KPI back to where it should be.

KPIs in practice

KPIs for a Manufacturing Company

A manufacturing company that had an aging product line with one major, and several minor customers, was looking to identify its KPIs.

They decided that they needed to develop some new products and to find some new customers so that they were less dependant on one major customer.  They also identified that their product costs were high compared to their competitors.

They decided on the following KPIs

  • % of Turnover spent on new product development
  • The number of proposals to new customers
  • The efficiency of their production process – actual output: expected output
  • The value of raw material scrapped
  • The value of raw materials rejected due to poor quality
  • % of on time delivery
  • Number of customer complaints

KPIs for a Drinks Distribution Company

A drinks distribution company had very healthy market share and profitability.  However, they detected a trend towards people buying in off-licences for home drinking.  Their share of the off-licence business was small so they set a goal of increasing the % of their sales to off-licences.

However, they were disappointed in the progress that they were making towards that goal. They reviewed what they were doing and realised that the main KPI for sales people was € value of overall sales.

What was happening was that sales people knew that the best way of hitting their sales targets was to sell big orders to chains and supermarkets but not to the target independent off-licenses.

So they changed the KPIs for Sales People so that Sales % to off-licences became more important.  Immediately a shift was noticed and within one year, they were close to achieving their target.

Conclusion

For your business, your KPIs are like the dash of your car.

You need to decide what you want to achieve and how you will do that.  Then you put in place KPIs that will measure progress towards your goals while also ensuring that your existing business processes continue to perform well.

It main take a bit of time to explore and finalise your KPIs. Realise that this time should be viewed as an investment in realising your vision.

Over to you!

If you have any questions about this article, feel free to contact me.

If you would like to have a discussion about KPIs let me know.  I would be delighted to help.

 

 

Assess your Financial Management Capability

The financial management capability of Irish SMEs varies significantly.

I have been working with many Irish SMEs over the past 20 years helping them to improve their financial management capability.  Over time, I have observed a number of different stages that businesses go through as they develop their skill levels.

I have set out in the table below the characteristics of the various stages that I have identified.

Not every business goes through all these stages nor does they spend the same amount of time in each stage.

A high potential business with external professional funding will usually put a high level of financial management capability in place from the start.  A start up that is growing organically will usually develop their financial management capability as the business grows.

Use the table to identify where you are and what you have to do to improve.

Levels of Financial Management Capability

Level
Activities Internal Outputs External Outputs Resources
Minimum Business run from bank statementss

Records sent to external accountant who does VAT, PAYE and prepares accounts at year end

None VAT Returns, PAYE Returns, Annual

Accounts at year end

Clerical Staff
Book-keeping Basic Record sales, purchases, payments and receipts.

Payroll Calculations using payroll software.

All files to the accountant at the year end

VAT Returns, PAYE Returns

Reasonably reliable customer, supplier and bank records

 

Annual Accounts at year end Book-keeper, not necessarily qualified
Bookkeeping Plus As Bookkeeping Basic with

Checks and Verifications on bank, supplier and customer balances

All files to the accountant at the year end

VAT Returns, PAYE Returns

Highly reliable customer, supplier and bank records

 

Annual Accounts at year end Usually qualified book-keeper with some experience, could be a trainee accountant
Accounting Basic As Bookkeeping Plus with

Management Accounts prepared at least quarterly incorporating accounting adjustments for stock, accruals and prepayments, depreciation

VAT Returns, PAYE Returns

Highly reliable customer, supplier and bank records

 

Management Accounts (at least quarterly)

P&L, Balance Sheet, Customer Balances, Supplier Balances

Usually qualified book-keeper with some experience, could be a trainee accountant

 

Part time controller for management accounts

Financial Control As Accounting Basic with

Management Accounts reviewed with Senior Management

Short term cash flow projections

Annual Budgets prepared

 

VAT Returns, PAYE Returns

Highly reliable customer, supplier and bank records

 

Reliable Budgets

Highly reliable management accounts

Including Actual v Budget P&L

 

Internal accounting staff with experience and some qualifications

 

Part time controller for management accounts, budgets and projections

 

Financial Control Plus As Financial Control with

Product costings from budget data

Short term cash flow projections

Financial Projections updated quarterly

VAT Returns, PAYE Returns

Highly reliable customer, supplier and bank records

Short term cash flow projections

Highly reliable management accounts

Reliable Budgets and product costings

Reliable projections

Basic analysis of variances

Financial inputs to decision making

 

 

Internal accounting staff with experience and some qualifications

 

Part time controller for management accounts, budgets and decision inputs

 

Strategic Control As Financial Control Plus

With multi year-long range planning

Full Financial Evaluation of all key business decisions

Robust financial model that can quickly support what if evaluation of various options

 

VAT Returns, PAYE Returns

Highly reliable customer, supplier and bank records

Short term cash flow projections

Highly reliable management accounts

Reliable Budgets and product costings

Reliable projections

Basic analysis of variances

Financial inputs to decision making

Long term funding requirements identified with plans to address them

Internal accounting staff with experience and some qualifications

 

Usually fulltime (but possibly Part-time) controller for management accounts, budgets and long range plans and for decision inputs

 

What does this mean for you?

You should use the characteristics in the table to identify where you are now.

Then you should ask if this is sufficient for you and for your business.

Ask yourself if you have the appropriate skill levels to do what you need to do.

Whereever you have gaps, then you need to put a plan in place to close the gap.

This plan should identify what must be done, who will do it and when will it be completed.

How I can help?

With many years’ experience working with SMEs I can help you complete your diagnosis and put improvement plans in place.

I can help you by coaching your financial staff to grow in to their roles or, where necessary, by hiring appropriate staff.

We can work together to create a practical plan to address the needs of your business.

Offer

I am offering a two hour assessment of your financial management capability with no obligations on your part.

This assessment will be restricted in that I can only offer one per week.

If you want to have your financial function assessed, feel free to send me an email with subject “Assessment of Financial Management Capability”.

 

 

 

Are your financial results different from what you expected?

Have you ever been presented with a set of accounts where your results not what you expected?  It’s really frustrating.

Maybe you’ve had a very busy period with strong sales and you are expecting to see a very healthy profit in your accounts.  Instead, you have a poor profit or even worse, a loss.

If you don’t know why you had poor results, how can you prevent it from happening again next year?

You ask your accountant why, but he/she can’t explain why.  They reply with some unintelligible jargon and you think that the problem is you – that you just don’t understand finance.

In the time I have been in practice, almost every year a new client comes along saying “my accounts aren’t what I expected and my accountant can’t tell me why?  Can you help me?”

Over time, I have come to realise that there are six common reasons why accounts can differ from what the owner/manager expects.

Underestimating Costs

Probably, the most common reason is that the owner/manager underestimates costs.  They may have prepared projections when they set up the business or a few years ago when they were looking for a loan.

In the meantime, they have added costs here and there – an extra employee, higher insurance, more travel, new machinery and equipment etc.   But in their head, they still think costs are what they were a few years ago.

They get a surprise when the accounts came out.

How to avoid this

Prepare a budget every year.  It actually doesn’t take that long.  And if you do it every year, you should have workings – ideally on a a spreadsheet – from last year that you can just update.

Also, take the time to review and understand the costs that you did incur.  Are they right? Do you remember incurring or approving of those costs?

If you have monthly or quarterly management accounts, this is very easy to do.  And if you have a good accounting software, you should be able to drill down into each expense type to understand them better.

Inaccurate Stock  Valuations

In my experience, most SMEs don’t understand the importance of the stock figure.   As a result, they don’t prioritise the annual stock take.

It may be that they think they can estimate stock reasonably accurately or it may be that they want to keep the stock low so that they minimise their profits.

Whatever the reason, understated stock means understated profits.

I worked with one retailer who carried out a rough stock take every year.  He walked through the shop and the store with an assistant recording the stock items and the stock value.

I persuaded him to install a Point of Sale system which had a stock module.  When they entered the stock items into the system they realised that their estimated stock value was way off.

How to avoid this

Do a reasonably accurate stock take every year.

At a minimum, apply the 80:20 rule.  80% of the stock value will come from 20% of the stock items.

Know what’s in stock and know what that is worth.  In that way, you will have a better understanding of the real profits.

Timing Issues

Most business owners do not understand the importance of timing.

If a supplier invoices you just before month end and you do not receive the stock items until after the month end, you will have a timing issue if you don’t record the transactions properly.

If you record a supplier’s January invoice in your January accounts but you don’t have the stock until February so can’t include the incoming stock in January then your accounts will reflect that  you bought something that you didn’t get.  You have a purchase invoice in January but nothing to show for it.  Your accounts are wrong.

Alternatively, if you receive goods but the supplier doesn’t invoice for a few weeks, then your accounts will reflect a “windfall”.  You have stock that apparently cost nothing.  Again, your accounts are wrong.

Finally, if you are working on a long project – a multi-month project you can have mismatches due to timing.

You incur costs for the project in month 1 but you don’t finish the project until month 3.  You don’t invoice until the project is complete.  Now you have costs in month1 but no revenue.   When you do invoice in month 3 you have revenue but no costs as they were taken in month 1.

Your accounts are like a roller coaster – up some months and down some months.  You can’t understand it and wonder how you priced those projects so differently.

How to avoid this

If you receive an invoice before the goods, then show those goods as goods in transit.

They are not in stock, you can’t physically count them but they are yours – you have been invoiced for them – so the best thing to do is to have a stock in transit. Put them in there and reverse that when they are received when they can be counted in stock.

If a supplier delivers in one month but invoices in a later month, identify the non-invoiced goods and put a provision in your accounts for them.  Accountants will call this accruing for the uninvoiced receipts.

If you have multi-month jobs, try to put a value of the work done but not yet invoiced and show that as work in progress.

Putting it into practice

I have a manufacturing client who buys packaging from another country.

Two or three times a year, they are invoiced for packaging in one month but that packaging is not received until the following month.  I have encouraged them to record the incoming goods as stock in transit.

That same client buys in raw material on a seasonal basis.  Sometimes the supplier will ring to say that his warehouses are full, and ask if they can take an order early.

They say they can but that they can’t pay for it yet as they hadn’t planned for it.  The supplier says no problem, he will invoice later as per the original order.

In this situation, I have the client making a provision for the invoiced items so that the accounts are more accurate.

I have another engineering services client who install and maintain expensive machinery for large businesses.  Many of their install projects take several months to complete.

It’s common for them to buy machinery for an install in one month but not to invoice for that job for another 3 or 4 months.  This can happen because the job can take several months or also because the customer may ask them to group several jobs into one invoice.

In this case, I ask my client to review all the jobs that are active at the quarter or year end and estimate the value of the work that is done but not invoiced.  They show that as work in progress so that the accounts are more reliable.

Poor awareness of Waste/Scrap

Sometimes a client has a lot of waste or scrap in their process but because they don’t measure it, the underestimate the cost of it.

In regulated industries, you may have to take a lot of samples.  The costs of these can quickly build up.

You may also be issuing samples to prospects.  Again, the cost of samples can quickly mount up.  I am not saying not to issue samples but simply to improve your awareness of the cost.

How to avoid this

Record and value the waste on an ongoing basis.  You should be doing this anyway as part of your process control and to help you identify improvement opportunities.

However, some more traditional businesses ignore it – treating waste as something they can do nothing about.

That may well be the case, but you need to know the real cost of it.  Also, there is always something you can do to improve it.   Maybe you can change suppliers.  Maybe you can tweak your process.  You should never stop looking for improvements.

Also record the number and cost of testing and customer samples.  It is best practice to show these as a separate line item in your accounts so that the readers of the accounts have a better understanding of your costs.

Excessive Discounts

Some businesses, particularly owner run businesses, have a practice of giving discounts to customers.  Customers come to expect it and its part of the buying process.

If the discounts given are not tracked and measured it can easily happen that they creep up and significantly reduce your gross margin.

How to avoid this.

You need to be able to accurately measure the costs of the discounts that you are giving.

If you have a point of sale system, make sure that it shows any discounts separately.  If you are invoicing have a separate line for customer discounts so that your accounting system will accumulate these discounts and report on them separately.

Putting it into practice

I had one retail client where the owner told his clients that if his customers came into the shop then they had already made a decision to buy and staff had to do whatever was needed to compete the salem.

Understandably, staff took this as an instruction to discount as much as was necessary to close the sale. The owner thought he was empowering them to discount up to 5%.   The reality was different.

When we installed a point of sale system, it became very clear within the first week that the staff were discounting up to 12% and the real cost of the discounts were much greater then the owner had assumed.

He quickly issued revised guidance on discounting.

Underestimating drawings

For non-company clients, drawings can be an issue.  For sole traders or partnerships, drawings are effectively the “net wages” that the owners are taking from the business.

Its important to realise that these are “net” so the tax due on the profits of the business remains to be paid separately.

The client may have decided to take, say, € 3000 out of the business for his/her “wages”.  However, over time they start to take money out maybe for pension, maybe to pay the annual income tax bill.  Maybe they set up a direct debit for a membership – maybe a gym membership.

Sometimes they transfer a little bit extra to their personal account if that balance is too low, but they forget about this when estimating the drawings.

When you ask them how much they are taking from the business, they just report on the € 3000.  When you do the analysis, you can see that they are taking the € 3000 per month, plus extra for the repayment of the income tax loan plus extra for the monthly pension contribution plus extra for the personal account top-ups.

How to avoid this

In this case, the key issue is awareness.  The client needs to understand what exactly is meant by drawings and to be able to get an accurate value on what they are taking from the business each month.

If they are using accounting software, which I highly recommend, I usually ask them to set up drawings categories (or account codes) for pension, income tax and possibly for irregular drawings.

Putting it into practice

I have one sole trader client who approached me because his bank balance had come under continuous pressure and he couldn’t understand it, as his turnover had increased and he thought his profitability was good.

When I analysed his bank account, I discovered that he was taking regular weekly drawings or “wages” as he called it. But he had also increased his pension contribution, a change he had forgotten about.  He had also begun to transfer money to his wife’s personal account as her separate business was not performing and she needed help.

When I showed him the data, he recognised immediately that it was correct, and he accepted that the real problem was that he had underestimated the total of his drawings.

Conclusion

These are the most common reasons that I have come across when investigating unexpected financial results and I have carried out this exercise for many clients over the years.

That’s not to say that there aren’t other reasons but these six areas are what I check first when I start on that type of project.

If you have problems understanding your financial results  and you want to discuss them please get in touch.

If you have comments, feel free to leave them in the comments section below.

If you  found this article helpful, you may also be interested in these other articles.

How to prepare Financial Projections

How much does it cost to open your doors?

Why a good budget is vital for every  business owner

 

Form of Business – Sole Trader v Limited Company

Which form of business?

If you are starting out in Business, you have several decisions to make.  A key decision is to decide which form of business to use.  Will you trade as a sole trader or will you  trade through a company?

You may not fully understand the difference between the two forms of business or the consequences of choosing one option over the other.  This can make the decision difficult for you.

Over the years while practising as an accountant, I have been asked about this issue many times.  Here is the advice that I give to my clients.

Firstly, what is the difference between a Sole Trader and a Limited Company

A sole trader means that you are trading as an individual i.e. yourself.  A company is a separate legal entity that is created for the purpose of carrying on an activity usually a trade.

In law, a company is a legal person and is separate from the owner(s).   This means that a company can enter into contracts and can sue or be sued.

As a sole trader, when you carry on your trade the other person is trading with you as an individual.  If the business goes bust, you will be liable for the full debts of the business.

As a company, you, and possibly others, will own shares in a company which carries on the trade.  This company can, and usually does, have limited liability so your personal liability is limited to the amount you invested in in shares of the company.

If the company goes bust, it will be liable for the full debts that is has and if the company cannot pay those debts the debtors cannot follow you for any more than you invested unless you have given personal guarantees over the debt of the company.

A sole trader will have to register as a trader with the Revenue Commissioners and will have to file an annual income tax return.   If the sales exceed certain limits, you will have to register for VAT.  If you have employees, you will have to register as an employer for PAYE.

There is more detail on VAT in this blog post What do you need to know about VAT.

A company will have to register with the Companies Registrations Office (CRO).  The company will also have to register for taxes with the Revenue Commissioners and will have to file an annual corporation tax return.   If the sales exceed certain limits, the company will have to register for VAT.  If the company has employees it will have to register as an employer for PAYE.

If you have a company and are working in the business yourself, then you are an employee of the company.

How do you decide on Sole Trader or Company

Do you intend to retain profits in the business?

In the early stages of many businesses, the owner leaves profits in the business to build up working capital.

Where the taxable profits are greater than what the owner plans to take out of the business by way of salary, then it’s usually better for the business to incorporate i.e. trade as a company.

The reason for this is that a sole trader pays tax on all the profits, but a company owner will only pay income tax on salaries or dividends taken from the business.

For a company, tax is levied at 12.5%, in most cases, on the taxable profits and the owner will also pay income tax on any salary or dividend taken from the company.

In a situation then, where profits are retained in the business, the combined tax paid is usually lower when trading as a company and in that situation operating as a company may be best.

Note, however, that if the company is a service company there may be a 15% surcharge on undistributed profits. This applies to accountants, architects, etc.

However, there are other factors that should also be considered.

Do you plan on investing in a pension?

Tax Relief on pension contributions is more restricted for sole traders than for company directors. If an individual wants to maximise a pension fund then it may be best to trade as a limited company.

What is your exit plan from the business?

Generally speaking, having a company is better for transferring ownership to children as you can allocate shares to the children.

In the unwanted event of failure, can you bear the liabilities

In businesses where there is a risk to the owner from significant claims against the business, then Limited Liability companies are best.

For example, if the liability for product failure would be high, then consider trading as a company.

Are there any specific rules or restriction for your business sector?

For some businesses, laws or regulations may not allow the business to be carried on by an incorporated entity. For example, it appears that while doctors can practice as unlimited liability companies, the GMS only awards contracts to individual doctors.

Do you plan on investing in Property?

In almost all cases, it is better to have investment property owned personally so as not to have a double tax charge.

If an investment property is sold by an individual the individual will pay capital gains tax on any gain.

If the investment property is sold by a company, the company will pay capital gains tax on any gain.  However, if the owner wishes to take the gain out of the company then he/she will pay income tax on the salary or dividend.

Raising investment Capital

Some tax incentives require the business to be incorporated so if you plan on raising funds under  the Employment and Investment Incentive Scheme (formerly known as BES) then you will have to have a company.

Tax incentives for Business Startups

There are more tax incentives for companies than for individuals.

Certain companies are exempted from Corporation Tax and/or Capital Gains Tax in each of the first three years to the extent that their tax charge from qualifying trading activities does not exceed €40,000.   More on this on the Revenue  website here.

There is marginal relief where the tax charge falls between €40,000 and €60,000. In other words, a company can generate up to €320,000 in taxable profits each year, at the current tax rate of 12.5%, for three years without paying any corporation tax.

Conditions apply which seek to ensure that it is only new businesses that qualify rather than businesses being transferred from another Irish entity or businesses being moved to a limited company from a sole trader/ partnership.

Conclusion

The information in this article is not intended to be a comprehensive overview of all the issues relating to deciding which form of business to use.  This is presented as guidance to help you decide if you need more detailed advice. You should seek professional advice before making any significant decisions.

If you have any questions, be sure to let me know by emailing me at jim (at) accountsplus (dot) ie.

 

Common Problems when working with accountants

If you are a business owner, you probably have an accountant.

The relationship you have with your accountant is very important.  Your accountant prepares and helps you to interpret the accounts for your business and ensures that you  comply with various regulations re reporting and taxation.

If this relationship is not providing you with the advice and inputs that you need, then you need to think about changing.  However, if you change you don’t want to end up back in the same situation – just with a different accountant.

I have been working as an accountant in practice for many years and, in that time, I have taken on several clients who left their previous accountant because of problems they encountered.

Let me explain to you what are the most common problems that have been reported to me and let me tell you how you could avoid or at least minimise these.

Little or no explanations for your results

You may have been expecting to see a certain profit but when your accounts are complete the results are different – usually not as good as you expected.

You look for an explanation.   You want to understand your business and to know what you can do to improve your results.

Your accountant can’t provide the explanation.  They just tell you that this is the answer we got and they can’t provide any other insights.

How to avoid this

Speak to existing clients of the accountant you are considering moving to and ask how the accountant has responded in similar situations in the past.

Give the accountant a couple of scenarios that you have had and ask what may have caused those.  You will learn a lot from how they approach answering these questions.

Little or no advice is given

Some accountants are reluctant to give advice.  I had one client who asked his previous client if he should renovate his offices. The accountant simply replied “That’s up to you.”

Technically, that answer is correct but what the client is really asking is “how do I make the decision.”

You need to be able to ask your accountant for help with major decisions.  Additionally, your accountant has access to all of your financial data and if he/she spots something that could help, you want them to tell you.

How to avoid this

When you meet with the accountant that you are considering moving to, have one or two questions that you can ask so that you can get a sense of how the accountant will reply.

You can also speak with other clients to see if they are provided with relevant and useful advice.

Too much contact is with junior staff

In many firms, the principal can be very busy and often delegates the interaction with a client to employees.

While its normal, and more cost efficient, for junior staff to do the number crunching work, you want your accountant to share his/her expertise and experience with you.

At a minimum, the principal should review the file, should become familiar with your situation and should provide analysis and advice.

Junior staff are unlikely to have the experience or the confidence to deputise adequately for the principal.

How to avoid this

When engaging with the accountant, ask with whom you will have interactions and clarify the purpose of the interactions.

Again, find out what happens with existing clients of the same accountant – not clients of his/her partners.

When the accountant is issuing the letter of engagement, you could consider asking that this letter be used to specify the type and nature of interactions that you will have with the accountant and his/her office.

Too much jargon

Many clients report that their accountant is no good at explaining things to them.  The clients give up asking because they don’t get the answers that they need.

Typically, what is happening is that the accountant is so familiar with the material that they unconsciously use jargon which is not readily understandable by most clients.

How to avoid this.

Test the accountant by asking him/her to explain something to you.  Bring a situation that you had previously or something topical for you now and discuss this with the accountant.

Ask existing clients how they rate the explanations of the accountants.

Hidden commissions or biased advice

Many accountants earn commissions on sales of life and pension products or tax based investment products.  They can also earn extra income by acting as resellers for software products.  These practices are more common with larger firms.

These accounting firms may have associated companies that sell software or financial services.  They may appear to be independent but the shareholders could well be partners in the accounting firm.

If your accountant is recommending something to you, they should disclose any fees or commissions earned that could bias the advice they give.

If they are a tied agent for a particular life and pension company, that should be disclosed as this relationship likely means that they will not have researched the whole market when selecting the product offered to you.

If they are connected to a company selling a product of service that they recommend, then they should disclose that.

How to avoid this

Don’t be afraid  to ask the accountant if they are earning any fees or commissions on any product they are recommending.

Consider asking them to operate on a fee rather than commission basis.

Consider asking them to include a statement in their letter of engagement relating to transparency around fees and commissions.

Recommending systems that suit only them

Some accountants want their clients to use accounting or payroll software that they already use themselves.

On one level this is fine, as it delivers efficiencies to the accounting firm.

However, if the software does not have the functionality that you need then it may not be the best fit for your business.  For example if you want to use cloud systems but they only work with desktop systems then their proposed solution is not a good fit for you.

How you can avoid this

Ask upfront, if the accountant has any preferences for which software systems they like clients to use and ask how flexible they are around this.

Do a system evaluation before you buy the software and implement any software to make sure that it’s a good fit for you.   I have an article on selecting accounting software called “How to choose accounting software”.

Mismatched Expertise

A friend or business associate may have recommended a particular accountant to you because they were very happy with the service.  However, you may have different needs from your accountant.

For example, your friend may have PAYE income and a rental income portfolio. You on the other hand have an engineering business.

Your friend will be looking for basic accounts and tax advice.  You could be looking for support with budgets, product costing and maybe business planning.

Your friends accountant may or may not be a good fit for you.  Pretty soon after starting to work with this accountant you will know whether you have made a mistake or not.

How to avoid this

Understand what sort of client base the accountant has.

Does he/she specialise or have sufficient experience in your particular sector?

Consider asking some questions along the lines of how do you handle particular situations unique to your sector. Consider asking if they can outline their experience with your sector.

Lack of contact during the year

Many accountants have little or no contact with their clients other than the few days or weeks when they are working on your accounts.

This may suit some clients but most clients will require some accounting inputs during the year.

Issues arise where it would be helpful to talk to an accountant.  You may have questions that you would like to ask.   There may be legal or technical changes that you should be made aware of.

Not having contact could lead to sub-optimal decisions or non-compliance with certain requirements.

How to avoid this

Talk to existing clients and establish what sort of contact they need and get.

See if this is covered in the engagement letter.  If not, consider including something around this.

Unexpected Fee Notes

Sometimes clients ring up with queries that they think are minor and the accountant should be able to answer off the top of their head.

On the other hand, the accountant sees a more complex issue and undertakes some research and investigation to make sure they are giving the best answer.

The result is that the accountant invests significant time and then bills for this time.

The client may not be aware of the amount of time that has been input and is very surprised when a large bill comes in.

How to avoid this

Its normal that the costs of responding to minor questions would be covered in the annual fee but issues that take more than 15-30 minutes to address may be charged separately.

In the engagement letter, include something to specify that the accountant will flag when something is going to trigger a separate bill.

You can then have a discussion to see if it your request is something that justifies that fee.

Also, check with existing clients of the accountant to see how queries are dealt with.

Why is AccountsPLUS different.

Over the years while working as an accountant, clients have often commented that I am very different to other accountants that they have worked with.  When I try to drill down to understand what they mean a few common responses come up.

They tell me that they can understand me.  They say that I give advice about improving performance and profitability.  They can see that I want them to understand the accounts.   They comment that I have a better understanding of their business because I am more hands on than other accountants they worked with.

I think it comes from my background and experience.  I relate well to non-accountants because  I qualified first as an engineer and I had no experience with accounting before starting to train as an accountant.

Then I went into industry and my role involved supporting management to understand the financial impacts of their decisions.  I could see the difficulty they had in understanding accounting information, but I knew that this was down to the way the information was presented.

I also have significant experience working on projects to improve profitability.  I can see how the accounting data can be used to drive the business and I try to use business software to organise the most relevant data and make it available to management.

Bottom line, my background is very different from most other accountants.

Conclusion

In many ways the accountant-client relationship is a project.  You need to have a good project definition up front.

You need to identify what you expect from your accountant and then have a discussion to ensure that your accountant shares your understanding.

Be very careful to do your homework before you decide to hire an accountant for your business.  You are likely to be working with your new accountant for several years and the relationship needs to be excellent.

If after reading this article, you feel like you need to change accountants but are not sure what to do,  I have an article on changing accountants that might be helpful – How diffcult is changing your accountant.

Over to you

Have you been experienced frustrations when working with your accountant?  What type of problems did you face?

I would love to you hear from you, so please leave a comment below.