As the owner of a small or medium sized business, are you leveraging your accounting process to help you save time, grow profits and take control? Yes, you’ve got your year-end management accounts from your accountant. And Xero gives you a whole range of different reports. But does this really add value? Is it making a real difference to you?
Here’s the rub… if your accountant hasn’t stepped up their game to understand your business drivers and what’s truly important to your success, then you’re leaving money on the table! Guaranteed…
Building Block 1 – Profit and Loss
Of course, the number one reason most people are in business is to make a profit. Even if you love what you do and can’t think of any other way you’d rather spend your time 🤔, surely an extra 4-5% margin would be great to pay the school fees, give you that awesome holiday you’ve been dreaming of, or even to employ an extra pair of hands.
So of course the profit and loss is a key financial report that you are no doubt monitoring on a regular basis. Everyone’s seen one, you can run one from Xero at the click of a button.
And it tells you your profit, of course, hopefully its not a loss… So isn’t that the beginning and the end of it? Well no, actually, you can glean plenty more information from a well constructed profit and loss format designed for your needs.
The first step is just that, setting up a report structure that reflects your business and will help you evaluate your ongoing business performance. Once that’s done, some of the key things to look out for on your profit and loss are:
This is the margin you make from your key selling activities, net of direct selling costs. This is the core of what your business does. What margin are you making on your key products / services? How does this compare to competitors in your industry? Do you need to reduce your cost of production, or increase your prices? Reviewing your gross profit margin (GPM) provides key profitability data about your business.
These are all the business expenses that are not directly attributable to the creation of your products and services. Eg rent, telephone costs, stationery. If your GPM compares well to competitors yet you’re profit is low, then Operating Expenses are to blame. Which expense lines are the key drivers, is there scope to cut costs?
This is a process of comparing metrics month-on-month or year-on-year. How are your sales, margins, expenses trending over time? Does this indicate an issue that you need to address?
Building Block 2 – Cash Flow
Cash is King! Most small and medium businesses live and die by their cash flow. So how do you manage your cashflow?
Cash is driven by 3 key areas in business. The main area being day-to-day business activities. This will differ from your profit and loss position based on timing of cash flows and the fact that certain operating expenses (eg depreciation) have no cash flow impact.
The second area of cash flows is that of investment in revenue generating assets. This could be machinery needed to produce your goods and services, or infrastructure for your business, such as buildings. The cost of purchasing these large items does not flow directly to your profit and loss, but it does have an immediate and potentially significant impact on your cash flow.
Third, financing activities such as bank loans and other borrowings and repayments (as well as capital raisings through share issuance) will also impact on your cash flow position.
One of the key ways big business manages its cash flow, is to tightly control cash payments and receipts from suppliers and customers, along with managing inventory holdings. These areas can be monitored by the efficiency ratios that we outlined in our recent Better Business Performance blog.
Off the shelf accounting systems such as Xero don’t manage cashflow forecasting well. They’re fine at looking in the past and telling you what the drivers of last month’s cash flow were, but the horse has already bolted…
Knowing the drivers of your future cashflow and keeping an eye on where you’re headed in your business, that’s when you can be really efficient in managing your cashflow. This will give you the ability to take one-off opportunities as they arise, to pay-off debt when its not needed, reducing costs and improving your bottom line. This is where the value of forecasting comes in.
Building Block 3 – Forecasting
Where is your business going? Is it growing as you expect? Are growing revenues being gobbled up by even bigger growth in costs? What are your expectations?
Setting budgets may sometimes seem like a boring and irrelevant task. But done well, its an invaluable process that creates accountability and a deeper understanding of your business as it develops over time.
Forecasting can be a simple or detailed process, you need to find a balance that suits your situation. But there’s two forecasting steps that are key to creating value in this process:
Forecast revenue from the ground up
This requires you to forecast key revenue drivers, such as customer numbers, new product lines, price changes etc. Developing targets for your revenue drivers puts focus on specific items that have a direct impact. Down the track when reviewing performance versus budget, this enables you to dig deeper to gain insights. If revenues are down, rather than taking that on face value and not knowing why, you’re in a better position to understand what has driven the result.
The alternative and most common method of forecasting, is to simply take last year’s number and increase it by 5%. Why 5%? Who knows, it just sounds like a good number… If there’s no valid reasoning behind an assumption, it gives no value when reviewing performance against that assumption in the future.
Review and revise
There’s no point setting forecasts if you don’t review them regularly. At a minimum, you should assess performance versus forecasts monthly. This is an opportunity to challenge your results and ask difficult questions. If you didn’t meet your forecasts, why? Dig deeper, find likely reasons and do something about it to change your trajectory.
You should also regularly update your forecasts. Logic says that shorter term forecasts are far more accurate than longer term forecasts. So with the additional knowledge and information you obtain each month about business conditions, competitive forces, results of your marketing campaigns etc, its a valuable step to review and update your forecasts monthly as well.
Building Block 4 – Bringing It All Together
With all the responsibilities you have as a business owner, how do you also fit in time to regularly work on, review and plan around these core financial building blocks for your business?
There’s 2 key answers, both of these will contribute to the process of saving time, increasing profits and helping you take control.
Engage an expert
Take bookkeeping for example. You most likely employ a bookkeeper to update and reconcile your accounts. Possibly even to invoice customers and run your payroll too. This is money well spent as the value of the resulting output (up to date and accurate accounts) outweighs the cost.
Similarly, is accounting and financial strategy your thing? If not, a strategically-focussed Chartered Accountant will be invaluable in bringing together your finances, reporting and strategy. This means digging much deeper than just preparing year-end management accounts and tax returns. Having an expert pair of eyes regularly looking at your business, critically analysing your performance and drawing insights to refine your on-going strategy can be invaluable to all businesses.
Use a reporting dashboard
With a huge amount of available information, you need a way of distilling key messages from your financial reports and KPIs. An effective dashboard tool will provide you with key visuals giving you an immediate, easy to understand analysis of your performance versus pre-defined metrics.
There are many dashboard options available, choosing one can be a minefield. A key feature of any tool is that it has the flexibility allowing you to design your own layout and metrics. Don’t fall into the trap of using a simple cookie cutter system. It will only result in cluttered reports of irrelevant information that you’ll ultimately stop using. A finance expert can help you choose and setup a tool that is right for you.
This commentary is general. Any any advice for your business would take in your specific needs and situation. If you’d like to discuss how you can save time, increase profits and take control, feel free to book a free initial consultation with our Chartered Accountant and Virtual CFO Andrew Terlich here.