Who uses management accounts?
Management accounts are information that provides the business’s financial performance—usually used by the following people interested in the industry.
- Owners/managers
- Investors
- Banks/lenders
- Factoring/invoice discounting
- Accountants
- Tax planners
Why produce them?
The owner has to know the sales, profitability, and shortage of cash & liquidity.
Most businesses don’t know their profitability, margins, and trends. So why bother? It’s a fundamental principle that if you can measure it, you can improve it, so it’s a no-brainer assuming you want to increase your net profit.
There are several key objectives in financial reporting:
- To measure past performance as a basis for improving
- To avoid cash flow problems and manage liquidity
- To have future visibility
- To determine where to focus attention to improve profitability
The information provided by Management Accounts helps to inform how each part of the business has been performing and thereby guides decision-making to benefit the company’s future performance.
Some specific reasons for producing management accounts:
Measure the gross margin percentage. The gross profit (sales less direct costs) you make from your service or product is divided by the sales value, excluding VAT. With this information, you can check your performance against others in your business sector. You can check trends over time, and you are then in a position to take action to improve your profits.
- It imposes a discipline of controlling the finances and may uncover bad practices.
- It will tend to reduce year-end accountants’ costs as the information will be better and more likely to be reconciled.
- Establish your break-even point for profitable sales
- Check and control overhead costs
- Control stock levels – measure trends, benchmark it
- Control debtors – measure trends, benchmark it
- Manage the working capital cycle – stock, debtors, and creditors
- Changing affecting the bank’s position
- Use key performance indicators (KPIs) to see what’s happening
Gross margin percentage
Most businesses do not know this information, but it is essential to measure this accurately. Suppose you sell £500,000 per annum. If you increase your margin by 1%, your net profit will increase by £5,000. What is so beneficial is to check the margin as follows:
Check the trend over time – establish why it has changed, either up or down. Examine every part of the margin, i.e., sales and direct costs, to see what can be improved, such as cutting out loss-making deals, increasing sales to profitable customers, etc. Examine it like a hawk as soon as it’s known each month – why has it changed? Benchmark against comparable businesses in your sector – how well are you doing, and should you improve?
Marketing for profit using management accounts
Suppose you sell £2,000 of product in a month and your direct cost is £1,200, your gross profit is £800, which is a gross margin of 40%. For the improvement of yields, the tendency is to focus on sales. A 10% increase in sales will generate £80 more profit, but a 10% increase in margin to 44% would increase profits without the significant effort required to increase sales.
Sales £2000.00
Direct cost 1200.00
Gross profit 800.00
Gross margin 40%
Formula: Total revenue- Cost/Total revenue *100= 40%
10% increase in sales= 200
To put it another way, if the margin dropped to 36%, you would have to increase sales by 10% to stand still. But if you don’t have management accounts, you cannot know what is happening to your margins. Thus, without management accounts, it isn’t easy to optimize profitability.
Once you know your gross margin as a percentage of sales, you have the knowledge to experiment with price changes as part of your marketing mix without the danger of going bust because your margin is wrong. If sales are not too good, many business owners think the best thing to trade their way out of the problem by reduce prices to win more deals. It is the worst thing to do in many cases, as it often hurts profits. Management accounts may show that increasing prices could be the better option.
Take the following scenario.
- For a product selling for £10, there will be a gross margin of 25%.
- Reducing your price by 10% to £9 means you must sell 66% more to make the same profit as before (£250),
- Yet increasing your price by £1 to £11 means you can afford to sell almost 30% fewer units and still make as much profit.
- Increased profits can often be through price increases rather than price reductions.
| Sale Units | Sale Each | Cost Each | Gross Profit Each | Gross Profit Total |
| 100 | £10 | £7.50 | £2.50 | £250 |
| 166 | £9 | £7.50 | £1.50 | £249 |
| 70 | £11 | £7.50 | £3.50 | £245 |
Typically, the price is up by £1 per unit, and sales fall by 30 units or less, or the price is down by £1 per unit and sales are up by 66 units or more.
How are management accounts produced?
The first requirement is a sound accounting system. It need not be complicated, but it must be good. You can use either an accounting package or Excel to do your accounts, but they need to check before preparing the management accounts. It will be advisable to get a qualified person’s help to produce them. It need not cost a lot; sometimes it’s free, but it’s an essential one-off check because if your accounts are unsound, you will produce unsafe or misleading reports, and hence you will likely make wrong decisions.
Armed with helpful information, it’s relatively straightforward to design reports to your requirements, even for a small business with modest accounting skills. You might need help, but it will probably be worth the investment