As a business owner you know you should look over your numbers regularly. You might even have some management accounts prepared by your accountant or bookkeeper and review the profit and loss account (“P&L”) once a month. In conjunction with looking at your bank balance and seeing enough to pay your team and suppliers, you consider that to be a good review and understanding of your numbers.
But what if I told you that just looking at the P&L and cash at bank isn’t enough? That you need to make some calculations based on those numbers to see if the business is as profitable as it should be, based on the people cost and overheads it’s carrying. Plus you need to understand the balance sheet and the image that is projecting to the outside world about the state of your IT business.
Review of the P&L
It’s absolutely right to review the P&L but what are you actually looking for other than to check the sales figure and to check the expenses incurred that month?
Well for a service based business, a really good check is the payroll to sales ratio. Working out how much your team are costing you versus the sales each month will immediately flag up issues with overstaffing or inefficient processes.
The trap a lot of businesses fall into is growing the team then not bringing on enough sales to pay for them, meaning you are carrying more cost without generating the income to pay for it so the business is actually less profitable.
Secondly, know what your gross margin should be and check that that is what the numbers are showing. If you think gross margin should be roughly 50% but the P&L is showing 40% then you have a problem somewhere. Either sales invoices targets haven’t been met or you are carrying more direct costs than you realised.
If you have a hardware element to your business there is a tendency to buy the latest kit because you need to deliver a project the client asked for; however, it not uncommon for a client to cancel, postpone, or leave you and in the meantime you are left holding the stock. In some IT businesses they have a warehouse full of stock which was purchased because the business owner has a passion for the latest kit and has a tendency to buy it assuming they’ll be able to sell it. This kit is often unsold, cluttering up a warehouse and has cost the business real cash it will never recoup.
Review of the cash
Just looking at your bank balance and having a gut feel for who you have to pay is not good enough when it comes to managing cash in your business.
When reviewing your numbers ideally you will have a simple one page cashflow that can be easily updated showing the outgoings for both the month and the 6-8 weeks after that. On a high level it can even show the next few months. As long as you are looking at the bigger picture and not just thinking it’s ok because you can pay the wages next month.
Review of the balance sheet
The balance sheet is often a mystery to a lot of business owners. They know they should understand it but honestly they don’t and need someone to interpret what it means and why it’s important.
Primarily the balance sheet is a snap shot of the business at a point in time, usually the end of the month or quarter or financial year end. It shows investors how healthy your business is and affects the businesses credit score.
If you are hoping to sell your business in a few years time then the balance sheet is something that a potential acquirer will want to see and understand as it shows the working capital situation, plus any debt in the company.
The balance sheet also gives an indication of payment performance so if you pay your suppliers later than the average company in your industry it will affect your credit rating, which in turn affects the company’s ability to raise finance.
Finally, the balance sheet will show the number of debtor days in the business e.g. how long it takes for you to get paid. If you are reviewing the numbers and ratios each month you’ll quickly notice if the debtors days increases and be able to nip any potential cash issues in the bud before they happen.
If you currently pay someone to prepare management accounts but you don’t cover the information above, nor do you have a meeting to run through them and establish how the business will perform in the coming weeks you are missing an opportunity to increase profits and manage your business growth.
If you would like to take a fresh look at your management information and see what value you can get out of the review process then let us know and we’ll be happy to share our tried and tested approach.