There has been a marked increase over the last few months in those seeking independent and experienced advice about the financial condition of their business because the overt signs are that the business has, or anticipates in the near future, trading difficulties that are likely to create cash flow challenges.
Without positive cash flow, a business can grind to a halt very quickly.
Seeking advice is a positive sign of a businessperson acting responsibly and, in such cases, one of the first questions is to provide a set of recent management accounts.
It is remarkable how frequently one hears the response that there are no management accounts or offered a set of annual accounts dating back a year or so that have never been read. Perhaps unsurprisingly, the next question will focus upon how the individual runs the business, to be met with responses such as “I just know”, “I’m there every day and I see what is happening” or “I keep an eye on the bank balance and if it is OK, everything must be fine”.
You would not expect to drive a car without a windscreen (how would you know where you were going?), a steering wheel (how can you guide the car?), sufficient fuel to run the car (how do you know you have enough cash to run the business?), or an effective instrument panel (how do you know how fast you are going, what might be going wrong and what indicators help to remain in control?). Thus, if you wouldn’t dream of travelling in a car without the relevant support mechanisms, why would you do so with your business?
For some, preparing management accounts is seen as an unnecessary and boring chore which wastes valuable time. However, working on the basis that positive cash flow is the lifeblood of a business, particularly when challenging times are being faced, it is fair to say that reliable, relevant and timely financial information is a basic fundamental of understanding any business activity.
It is accepted that a page full of numbers might act as a sleeping pill for many, but it is not a sign of weakness to admit that something provided in a more understandable format would be helpful. For example, graphs, pictures or a brief narrative might be preferred.
Every business will have Key Performance Indicators “KPIs” which may well be sufficient to retain overall control over the financial position, with supporting schedules that give more detailed analysis as required. For example, a firm of lawyers might look at the monthly level of staff utilisation, chargeable time invoiced to clients and cash collected. Broadly speaking, if these three KPIs are at, or above, a pre-determined level, the financial basics of the business are in place.
Whilst your KPIs will be wholly relevant to your business activity, without looking at trends e.g., what do the figures tell you every month/quarter as the year progresses, it is difficult to form meaningful conclusions. Preparing management accounts that are both informative and understandable is an easy process to adopt once the basic framework has been agreed. Further, the information is likely to be used rather that left in a drawer to gather dust.
As part of this process, a well-run business should have a financial forecast for at least the next 12 months i.e., rather than simply hoping for the best. If you look at the forecast and the results are not as anticipated, it is easier to determine why and take corrective action: sooner rather than later so that bad habits don’t become established.
Returning to the car analogy, if you want to go from A to B but do not have a map, how will you know the route, how you will know when you have deviated from the route, and how will you know when you have arrived? Management accounts will address all of this, and in a format that you find useful.
As one might expect, a financial forecast is likely to concentrate upon sales, costs and cash flow, which evolves neatly into a business plan. For the avoidance of doubt, a business plan does not have to be a detailed document that costs thousands of pounds and never sees the light of day: it could be one or two pages with relevant KPIs.
Basic tools a must
The inevitable conclusion is that without the basic tools of monitoring and controlling the finances, it is quite easy for a business to run into financial difficulty without realising it, and then left wondering why that was allowed to happen. Worse, it may be too late to take corrective action with the result that undue harm is caused to the business – or it fails.
Accountants are helpful and approachable. They have experience of this aspect of a business. Never be afraid to speak to them as often as you can.
Michael Reid is managing partner at Meston Reid & Co, an Aberdeen-based chartered accountancy practice with strong expertise in tax, audit, insolvency, corporate finance, business advisory, payroll and landed estates. The firm, based at Carden Place, has a broad range of clients, from contractors in the energy sector to large businesses with international operations.