You Can't Drive your Business by Looking in the Rear View Mirror!
Knowing your numbers is essential to running a great business! Sure, as a business owner you would rather have a root canal than spend your time with your head in the books, but it doesn’t have to be that painful. In fact, it can actually be fun (especially when the key success indicators start to grow). It’s also important to plan your cashflow, avoid the unexpected, and accurately forecast so that you can plan for growth.
If you’ve ever worked as a senior manager in a large company you probably had exposure to “Management Accounts” and to good accounting practices. That doesn’t mean you know how to operate them, but at least you have an idea of what’s involved. But if you’re like most, you lack hands-on experience and accounting concepts remain a bit of a mystery.
The truth is, the vast majority of business owners aren’t on top of their financial picture. They tend to think that the condition is unique to them and that everyone else has it all figured out. But that’s just not true. Business owners often avoid accountants or financial planners, fearing difficult questions that could expose a lack of knowledge and cause embarrassment. If this is describing you... it’s time to get to know the numbers.
The fact is,
80% of businesses fail within the first five years...
and it’s often because of poor financial management.
But it’s not as mysterious or difficult as you think, and once you’ve mastered it, your business will perform much better, and you will rest easier!
First let’s explain the purpose of annual accounts. The Government requires every business to submit annual accounts that report on profit. Guess why: Yep, it’s so that the Government can collect taxes. But your annual accounts have little to do with telling you what you need to know to run the business... it’s all about paying tax!
So if you look at your annual accounts and ask “what does it really mean to the business?” you’re barking up the wrong tree. In fact, your accountant’s job is to understand taxation so they can reduce your profit, for tax purposes, and get you into the lowest tax bracket possible. That won’t help you understand how your business is actually doing.
What every business owner needs are known as management accounts. These are the building blocks of what make up a Profit and Loss, or Income Statement. It’s data that helps you understand what has been happening in the business, and predicts what will happen, so that you can make good decisions promptly (not at the end of the year).
Heck, there’s no point waiting until your accountant tells you months after the end of the year that you made a profit or a loss! That’s like driving by looking in the rear view mirror.
Here’s the key: there’s no absolute definition of what should be in management accounts. It’s whatever is key to your particular business. Typically it’s going to be broken down under headings such as Revenue (to track your income), Cost of Sales (to track what you spent in order to earn your income), and Overhead (the fixed and variable costs necessary to run your business). This should enable you to see, on at least a monthly basis, an estimate of your profit and how you achieved it.
Your accountant might be able to provide you with monthly management accounts, but it’ll be in addition to doing your annual tax accounts, and you’ll be charged. Instead, put the task of organizing and maintaining your management accounts with a bookkeeper.
How to create management accounts
If this is new to you, or in need of improvement, here’s how to start. Create a spreadsheet broken down into the sections as described above as row headings. Each column should be a month, starting with the first month of your financial year and continuing for a full year, with totals for the year. Near the bottom will be a calculation of Gross Profit - your Revenue minus your Cost of Goods. And right at the bottom will be an estimate of the net profit - all the revenue less all of the expenses. What you want to see is how much profit you’re making each month.
Start with estimates in every section as a forecast of what you expect, then replace with actual numbers as you know them each month to see the reality. (Or keep forecast and actual in separate columns so you can see the difference!). Aim to have completed management accounts for a month by about 5-10 days into the following month.
So, after each month is complete you can see whether you achieved what you set out to, and if not, where it was different. This is the key point - by knowing this you make management decisions. Without it, you’re running blind - potentially off a cliff, or worse, into the dentist office for that root canal.
When you know your numbers, you can make the right decisions to maximize your profit.