In my last blog post, I gave an overview of management accounts to help you understand if they could play a role in helping you manage your business finance.
In this article, I want to go a little deeper into how you use them and the sorts of business situations where they play a role. These are many and various, but let’s look at three broad scenarios.
The efficient running of a stable business
Let’s imagine in this scenario that your business is in a stable, healthy position. You don’t have any major sales or profit issues, nor are you trying to take too much risk to accelerate growth. The KPIs that you should have a focus on are:
Net Profit – turnover less all costs and overheads
This reflects the overall profit/reserves of the company. In a stable company, this figure should be comparatively healthy, indicating sales prices are high and costs are controlled. This should not be mistaken for cash! If companies are stable but have no or little focus on their finances/costs the net profit could easily convert to a loss if the marketplace changes.
Non-Financial – customer satisfaction surveys, competitor research
Business KPIs aren’t only numeric. If your business is stable you should still be keeping an eye on how your customers feel about your value and whether there are any threats from competitors or wider market forces
Sales per salesperson/division
If the overall sales position is healthy, you can afford to have a slightly more granular focus. Are your sales teams performing equally or are some strong performers masking weaker ones? You’ll want to have a way of measuring whether you have any capacity to increase sales to further develop the business.
Managing growth of a developing business
In this example, let’s create a more dynamic scenario where you’re making positive, rapid growth and your KPIs need to guide you to make the right decisions in a more fluid situation.
Current Ratio – your overall solvency
Companies need to meet their financial obligations on time to maintain the positive credit rating that is so crucial for growth and expansion. The “Current Ratio” KPI weighs your assets, such as accounts receivable, against current liabilities, including accounts payable, to help you understand the solvency of your business.
Budget vs Actual – keeping an eye on the trend
This KPI maintains a control of costs and revenue during the period of change. It determines if the budgeting process is realistic and controlled. This is important during times when you’re operating with confidence, based on a belief you had at the outset of that period. Things change, you can over-extend yourself and it’s crucial to not rigidly follow a plan if evidence suggests you aren’t quite where you thought you would be.
Gross Profitability – by business segment
This is a KPI that you would want to ensure is healthy before embarking on expansion. The gross profitability position of each of your services/products should be checked to ensure no one income stream is lurking as a loss maker, masked by others, before you invest for growth.
Stock Turnover (product only) – stock divided by cost of sales x 365
This determines how long a company holds its stock before it is sold and turned into cash. A high stock turnover indicates that the company is struggling in selling its products or is holding obsolete stock. Conversely, a low stock turnover indicates that cash is not tied up in stock or it has reduced funds to purchase new stock.
Turning around a struggling business
Lastly, if your business is going through tough times then KPIs can play a role in having less worry caused by uncertainty. In this position, you need to know exactly where to focus your efforts to bring the business back to stability.
Working capital ratio (immediate cash available)
This calculates current assets divided by current liabilities including loans and investments. It shows how much liquidity the business has and how well it can pay it creditors/employees. The higher the ratio, the better the business health.
Debtor Days – total debtors divided by turnover x by 365
Shows the average days your customer takes to pay what they owe and how effective your credit control procedures are. Rapid changes in this figure can highlight individual client accounts which are having a significant negative effect and who need your attention.
Gross Profit – turnover less purchases
This reflects what the gross margin is on sales before overheads. It guides you on your sale prices, the higher the GP the better and indicates that you have your costs in control.
Net Profit – turnover less all costs and overheads
It’s sometimes easy to allow improving gross profit to make you relax and feel you’ve turned a corner because it hasn’t accounted for annual overheads or your tax position. Gross and net profit should always be measured comparatively in this situation.
These are just a few scenarios that I encounter every day in helping businesses manage their financial commitments. But every company is unique and has its own challenges, so If you’d like to understand more detail about how you can take control of your business finance and produce management accounts that help your current situation why not come along to my Business Finance Club. It’s based in Dorset, meets monthly and is a friendly forum for business owners and accounting professionals to share knowledge. You’d be most welcome to join us.
Alternatively if you’d just like to chat on a 1-1 basis then my door is always open. Do get in touch.
I’ve also produced a free e-book on the role of management accounts. It’s packed with useful tips on how to understand the subject and plan better.