The biggest and best performing businesses all prepare management information to monitor how they perform. They wouldn’t do it if they didn’t get real value from it, but what came first, the success or the management information?
We believe that management information is essential for all businesses – but the detail of it can be suited to the type of business and its business life cycle. The objectives of the business owners also influence the amount of management information required.
There’s a theory in economics that says if a business has perfect business information then it will make perfect decisions and fulfill its potential to the maximum. Now we don’t live in a perfect world, but if you follow the theory through then it concludes that the better the information a business has the better its decisions will be. Cost plays a part here and in the real world we have to play the cost against the value and find a sweet spot that suits us best.
If you’re going to measure something then you need to have something to measure it against and that’s where planning comes in. Businesses need to know what they are looking to achieve and also what they need to achieve as a minimum.
So it is better for businesses to have a budget, both for sales and expenditure and in the case of businesses making and selling a product you need to know what your margin should be.
Once you’ve worked out what your overheads are then you can look at your margin [if applicable] and calculate your break even point in terms of sales. Here’s a simple example, lets say your overheads for the business work out at £7,000 per month and the average gross profit percentage you achieve is 50%. You need to sell £14,000 per month before you will make a profit.
Break even analysis
This allows even the smallest businesses to prepare basic management information and check their performance. Using the example above if the business is confident about the margin achieved, they can very simply work out how much profit they have made in a month. If they sold £20,000 worth of goods then they would roughly make £3,000 profit in a month.
This can also help with simple decision making. If we’ve already sold £20,000 for the month but we get the chance for an extra order, but at a lower margin, we can decide to accept it based on the fact that we’ve already covered out overheads for the month and so whatever gross profit we make becomes net profit.
Conversely if their sales were £12,000 they would have made a £1,000 loss. If this continued then something would need to be done to correct the situation as this could not continue forever.
Without this basic analysis the business could continue until its yearly accounts are prepared perhaps 15 months after the losses started and by then a lot of money could have been lost. It’s better to know how you’re doing sooner than that!
More complex businesses
The above assumes a steady margin and predictable overheads, as businesses become bigger and more complex this simple approach is prone to error. Also with expanding businesses sales, margins and overheads can easily get out of control.
Where a business has many product lines with different margins and different arrangements for each customer, we won’t know what our gross profit percentage will be due to the mix of all the different margins.
This is where formal management accounting is needed to measure performance. These would compare actual results with budgets and tend to be quite accurate. Armed with this sort of information the business owners can see what they’ve done well and what needs improving.
Sometimes without seeing the consequences of decisions in financial terms they may not be understood or that understanding comes too late and has already cost the business dearly.
Examples of this we have seen include generous commission payments or ambitious marketing campaigns that have not achieved the desired results. Shrinkage from fraud, high levels of waste, or out of control spending can only be spotted early by the use of management accounts.
Should you have the accounts prepared monthly or quarterly, the truth is it depends on the business and how complex it is.
Generally a simple service industry business with fixed costs [like an accountancy practice or a solicitor] might only need accounts quarterly, together with a monthly headline review of key numbers such as turnover, salary costs and total overhead. The detailed quarterly accounts would then pick up any serious trends.
But a manufacturing business would need monthly management accounts and these would be essential in our opinion.
So what’s the answer?
The general answer in our view is that management information is essential for all businesses, but depending on the type of business, these can be very basic or very detailed, and their frequency depends on its complexity and status.
The next step
Whichever category you fall into you should speak to your accountant who can help you get set up and allow you to enjoy the benefits that management information gives the best and biggest businesses.