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How can management accounts be used effectively?

Produced monthly or quarterly, management accounts contain financial data that business owners can use to make decisions.

As a small businesses owner, success is always on your mind and amid your busy schedule, you are likely to receive a set of financial reports from your accountant every month or every quarter. These are management accounts and their purpose is to give you a snapshot of the business activities. The data also allow you to find out how healthy and resilient your business is – for example, is your business running efficiently? Does it have enough cash to pay its bills? How much working capital should you retain in your company?

At Tax Agility, our chartered accountants for small businesses in London send out management accounts to our clients regularly. What goes into each set depends on the clients and their business activities but typically each set may consist of:

  • Executive summary
  • Profit & Loss
  • Budget variance
  • Balance sheet
  • Aged receivables
  • Aged payables
  • Cash summary

In this article, we aim to discuss some vital data in management accounts that require the attention of small business owners.

Executive summary

An overview of your financial information, this shows the performance of your company, income and profitability in a given period.

Profit & Loss

P&L for short, a Profit & Loss account shows your company’s income minus its expenses. The income can be from sales or other sources like interest earned. On the other hand, expenses can be directly linked to your sales (known as cost of sales) or they can be general operating expenses like rent, insurance and office supplies.

If your income is greater than your expenses, then you have a net profit. But if your income is less than your expenses, then you have a net loss.

It must also be noted that your net profit (or net loss) does not equate to the cash your business has in the bank. For instance, last month you sold a dozen of office chairs to a dozen of clients and they are recorded in your P&L, but only half of them have paid you. The money owed to you by customers who have yet to pay is considered accounts receivable and it is recorded in your balance sheet which we will explain later.

A typical P&L usually has the following components:

  • Income
  • Cost of sales or cost of goods sold
  • Gross profit (income less cost of sales)
  • Expenses, anything from rent, national insurance, IT support, legal expenses to subscriptions
  • Net profit or net loss (gross profit less expenses)

How is the P&L account useful?

1. Determine efficiency

Gross profit (the difference between your income and cost of sales) is an indicator of efficiency. If your gross profit is high, it means your business is keeping more money from each sale made and is efficient.

2. Determine profitability

If your business is recording a net profit, you know that your business is selling products or services that are desirable and well-received, your price structure is right and your expenses are controlled.

3. Work out tax payable

All taxable profits made by your company are subject to corporate tax (the rate is 19% at present).

4. Work out dividends

Many small business owners draw a low salary and use dividends to make up the income. If you are taking this approach, you can only declare dividends to you and your fellow shareholders after the company has paid its corporation tax.

Budget variance

The budget variance shows you the original budget versus what was actually earned and spent in a specific period. Ideally, you want the actual figures to be as close to the budgeted figures as possible.

How is the budget variance useful?

1. Identify issues

Assuming December is a good month to sell toys and accordingly, you have a healthy £10k budget for toy sales in that month. But when January rolls around, you realise that toy sales were only £2k in the previous month, well below the £10 budgeted figure. In this case, the sooner you find out the reasons, the better it will be for the business.

2. Minimise careless spending

Assuming your marketing budget is only £1k a month, you are not likely to splash out on TV advertisements without knowing what positive results they can bring. Instead, you are likely to use the budget wisely, such as using the money to target online shoppers or run advertisements in your local areas.

Balance sheet

A balance sheet shows you what your business owns (assets) and what it owes (liabilities) at a given moment in time.

Assets

Assets are divided into current (items of value that can be converted into cash within the next 12 months) and fixed (items that cannot be converted into cash quickly). Examples of current assets are cash, accounts receivable and inventory while examples of fixed assets are equipment, vehicles and goodwill.

Liabilities

Liabilities are financial obligations that the business must fulfil. Liabilities are divided into current (bills that the business is expected to pay within the next 12 months) and non-current (bills that the business cannot settle within the next 12 months). Examples of current liabilities are accounts payable, PAYE payable, wages, pensions, VAT, among others. Examples of non-current liabilities are long-term loans and deferred tax (deferred tax usually happens when your financial year does not match the tax year).

Equity

For a limited company, the first line under equity is usually capital, which means the purchased shares. The next lines are current year earnings (net income or loss of the business for the current year) and retained earnings (reserves of profit made in previous years). Total equity refers to the assets left in the business after it has paid its bills and you (the shareholder) can have a claim to.

How is the balance sheet useful?

1. Compare performances

If you compare the numbers between two specific time periods, you can see if the business has performed better or worse. For instance, last month you had £10k in your net assets versus £2k a year ago, this means your business is doing better when compared to the same period a year ago.

2. See how the business is being funded

The formula for debt to total assets ratio is total liabilities divided by total assets. If the ratio is high, it means the company relies on borrowed money and money owed to others to operate, which is worrying.

3. See if the business can meet its financial obligations

The formula for liquidity ratio is total current assets divided by total current liabilities. Assuming your total current assets are £50,000 and your total current liabilities are £10,000, you have a ratio of 5, meaning you have £5 to cover every £1 owed, sufficient money to meet all short-term obligations.

Aged receivables and payables

Aged receivables or aged debtors show outstanding amounts your clients have yet to pay you. These invoices are usually outstanding for 30 days or more. In England, small business owners are painfully aware of the negative impact of aged receivables – they limit your growth and development, which in turn can put your business in jeopardy.

Aged payables or aged creditors, on the other hand, show you which suppliers your business owes at a particular time and how much you owe them.

Cash summary

Sometimes the management accounts also include a cash summary – information about your cash flow like how much money is leaving your company and what is coming in for a selected period. Ideally, you want the inflow of cash to be greater than the outflow, otherwise you will have something called a cash flow gap.

Cash summary is a powerful tool as the data allow you to rethink your budget and reallocate your resources. For more information about cash flow management, this article “Five ways to improve your company’s cash flow” will make a good read.

Sharpen your management accounts with Tax Agility

At Tax Agility, we have been championing small businesses across London since 2008. Our team of chartered accountants for small businesses work closely with our clients and our objective is to help your business grow.

Knowing that you are busy, we run management accounts for you and explain the key findings clearly, some of the things we look for may include:

  • Compare your original budgets versus actual
  • Check if your business is operating profitably
  • Check if your costs are under control
  • Work out how fast (or slow) your stock is turning over
  • Work out how many days your customers take to pay you
  • Determine how much sales you need to cover your expenses
  • Determine if your business can survive in an economic downturn

Based on this data-driven information, you can make sound decisions like the followings with confidence:

  • Evaluate which products or services are profitable
  • Work out the optimal sale price and allocate the right resource to sell your products/ services
  • Determine the financial effect of your management strategies
  • Lower your expenses
  • Modify your budget
  • Plan for the future
  • Measuring results

At the end of the day, every business deserves the best opportunity to succeed and your business should be no exception. To make money, your business needs to run efficiently, control costs, and sell products or services that meet the demands of your clients. Using data from your management accounts, you can make the all-important decisions that keep your business healthy and on track.

Tax Agility is here to help small business owners

Any questions you have pertaining to your management accounts, give us a call on 020 8108 0090 or use our online form to get in touch. The first meeting is always free and without obligation.

Our philosophy is simple: You win, we win.

 

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This blog is a general summary. It should not replace professional advice tailored to your specific circumstance.