A conversation with a director of a small business earlier this week gave me pause for thought. It went something like this:
Me: How often do you review the management accounts?
Business owner: We don't really do that, we just look at the bank balance.
I think this conversation will resonate with many readers. According to studies, around a quarter of small businesses in the UK do not produce management accounts at all, and less than half produce them regularly.
For businesses at the smaller end of the scale, usage will be even less common. Are they missing an opportunity?
To be clear, the term “management accounts” can mean simply a profit & loss account and a balance sheet. For many smaller businesses, this is mostly all we are really talking about.
Pretty much any business produces these things at least annually (for the purpose of completing tax returns – if nothing else). But when this is done only once a year (and perhaps several months after the end of the year) then its value as a management device is extremely limited.
With the advent of modern accounting software, it has become a lot easier to maintain financial data and produce decent quality financial reports. Used correctly, the information can provide so many insights into any business's financial performance and position, leading to better financial decision-making. So why don't more small businesses use the information at their fingertips?
Let's consider the options:
Complex to produce?
Is the information viewed as too complex to produce?
Businesses that have adopted modern accounting software (e.g. Quickbooks, Xero) should generally be in a position to produce reasonably accurate management accounts without significant difficulty.
Whilst it is rarely simply a case of running a report off the software, it often entails limited additional work. Businesses that carry significant stock, operate longer-term contracts or bill intermittently (for example, construction businesses) will need some level of additional financial processes to make sure the numbers stack up.
Nevertheless, with some additional work most small businesses should be in a position to produce reasonably accurate management accounts these days. So I am not sure that the complexity of production is a big driver.
Complex to interpret?
Are management accounts too complex to interpret? That is quite an interesting question. Business owners often have to wear “many hats”, not only finance but also, potentially, things like marketing, people, or operations.
As an accountant, understanding the numbers is second nature but I appreciate that finance can be a challenging topic for many. The reality is that many small business owners struggle to interpret a set of accounts.
Though the key to addressing this is probably better financial education (starting in school!), I do believe that accountants also have a role to play in helping the business community (and perhaps even the wider community?) to improve levels of financial literacy. Mastering the basics is the important bit really.
At Scholes, we are always happy to assist our clients to understand what their financial information is telling them about their business.
Cost
Is the cost of producing accurate, timely management accounts considered to be prohibitive (compared to the benefits)?
This goes back to my earlier comments about accounting software. Small businesses that already maintain accurate financial records on modern accounting software should, in the majority of cases, find that the incremental cost of turning that data into useful management accounts is generally very small, particularly in comparison to the resulting benefits.
Time constraints
Do time-constrained owners consider the review of management accounts to be a lower priority than other activities?
Time constraints are sometimes quoted as a factor here, though isn’t that rather surprising?
Ultimately, running a sustainable business is a numbers game, and without access to accurate management accounts can the owner or board really know if things are heading in a good or bad direction?
As any small business owner knows, time constraints are an ever-present factor, and this drives the need to prioritise what really matters.
Perhaps management accounts should be higher up the agenda for some small businesses?
Benefits
Are the benefits of reviewing management accounts perceived to be insignificant?
Let's return to the common alternative: checking the bank balance/ bank statements. Whilst monitoring the bank balance can offer a simple and direct way to understand how much cash is available, and perhaps provide some insight about cash flows, there is no question that on its own the technique has serious limitations as a financial management approach.
It offers no real insight into the business's profitability or its overall financial standing. It does not help to identify potential cash flow shortages or aid with budgeting. It rarely offers any real insight about the corporation tax or income tax liability either.
By contrast, reviewing accurate management accounts periodically will offer wide-ranging and valuable insights into all these areas, and many more.
Technology barriers
Does the accounting system not support the production of timely, accurate management accounts?
To return to a previous point, those small businesses that have already made the transition to modern accounting software should find that technology is no longer really a barrier to the production of accurate, timely management accounts.
Those who haven’t yet made the move to modern software may find that the ability to produce useful and timely financial information is a compelling reason to consider doing so in the near future.
Final thoughts
It is difficult to conclude on the reasons behind the low levels of use of management accounts among smaller businesses (relative to larger businesses).
My personal feeling is that a major factor is a lack of confidence among small business owners in understanding what the numbers mean.
This is coupled, perhaps, with an under-appreciation of the benefits that can be gained by more frequently reviewing, interpreting and acting upon what the data is saying.
In those respects, we continue to work hard to support our clients to achieve more value from their management accounts.
