A few years ago, I asked my brother if his photography business was making money. He stared at me for a while before admitting that he didn't know. To all intense and purposes, it was as far as he and any external observer was concerned. His studio was one of the best known in Akwa Ibom, he was in very high demand and he had money in the bank. The question I'd posed however was not answered by any of those factors. A few weeks later, my brother called me with the answer to my question. No, he was losing money. The fact is, the average SME have no idea if they are making money because the practice of maintaining monthly or quarterly financial information is not standard practice. It's time consuming and boring, and whilst it can be hired out a freelance Bookkeeper or Accountant, it's seen as an unnecessary expense.
Understanding the financial position of a business, no matter how big or small, is paramount to success and survival. A fact even more pronounced in the current economic climate in which we find ourselves. It is not enough to just look at the business's bank balance, all that reveals is how much is in the bank. Maintaining monthly or quarterly management accounts helps business owners to keep track of the business' finances and are necessary to make informed business decisions around expanding into new product lines or services, growing into new markets as well as been used to secure trade finance or a business loan.
A standard report includes a profit and loss statement, cashflow statement and balance sheet. Whilst they are not a statutory obligation, below are some of benefits of management accounts:
As already mentioned, the bank balance is not an indicator of business health. These reports enable you to observe important data like trends. So if you are a commodity exporter, understanding the true impact of seasonality beyond growing season is non-revenue generating and harvest is when you reap the financial rewards will allow better business decision making. You can see what's happening on a period on period basis - be it month on month or year on year. Analysing sales performance against these metrics give a better picture of business growth. If you understand where the gains are been made, you know where to concentrate resources and where to reduce them, now and in the future.
This was the biggest revelation for my brother. Not only did he realise that he was spending far more than he was making but he needed to review his pricing strategy. The report reveals the actual amount that is been spent, where it is been spent and if it is necessary - the cost of doing business. Things like how much does it cost to deliver a product or service, can raw materials be sourced more cheaply elsewhere whilst retaining the quality or can the cost of the product or service be increased, are all staff necessary (African businesses are notorious for over staffing), is there any machinery been under utilised, overstocking of products resulting in waste and so on. Transperancy on the full cost of getting a product into a customers' hand is the only way to know what the real margins are or indeed, if there are any profit margins at all.
Because management accounts reveal the business' financial history, you can see the budget against actual expenditure. This means you have a clearer idea of what the future looks like, what you can and need to spend on versus what you don't. This is particularly important for exporters or businesses been paid on a deferred basis. Knowing and managing your cashflow position can reduce a business' reliance on multiple credit lines which leave the business over exposed.
Any irregular spend or invoicing patterns can be identified quickly rather than waiting a whole year to discover them. Longer periods of financial review simply allow any fraud to go on for longer or make it more difficult to be spotted at all.
Any business seeking trade finance will be expected to have management accounts. The finance provider use these reports to determine a number of things including the ability to pay back the finance sought, the ability to operate whilst awaiting payment from buyer as well as looking at how the business survived any economic shocks - commodity crash, economic recession, currency instability and now COVID will be added to that list. Furthermore, possession of these reports demonstrates that you have full control of the business and the financiers money is in good hands.
Management accounts should be standard practice in any business. Having the right information enables businesses to navigate their way through tough times when difficult decisions need to new made as well as make the right the decision during good times as the business grows, which comes with its own unique challenges.