Management accounts are an essential tool for the small business owner who wants to develop and improve their business.
A good set of management accounts should provide accurate and timely financial information about how the business is doing, so the owner can make important decisions with a reasonable degree of confidence.
Unfortunately, though, the opportunity may be lost if the underlying financial information is inaccurate or delivered late.
Whether you run your own business, or you are a bookkeeper maintaining the books for someone else, I hope the following list of common problems may help you avoid some of the pitfalls.
Incorrectly categorising expenditure
Expenditure may be categorised incorrectly. A very common example concerns capital expenditure that has been posted to profit & loss. As a general rule, if a company is buying tangible items for long-term use within the business, the cost goes to the balance sheet as a fixed asset, not to P&L.
Remedy: take care when posting expenditure and ask your accountant if in any doubt about the classification of a particular item.
Putting personal expenses through the books
Companies have separate "legal personality" to the owners/ employees, so personal transactions should generally be kept completely separate from the business. Where a company settles a personal liability, there will often be tax / NIC consequences for both the company and the individual, so it is sensible to seek advice when in doubt.
Remedy: keep personal transactions separate; if it is proposed to put personal transactions through the books, seek advice as to any potential tax implications.
Not dealing with cut off correctly
Accounts prepared on the "accruals basis" are supposed to show the economic effects of a business's activity, rather than simple cash flows (which on their own rarely tell the whole story, and can be very misleading). When preparing quality management accounts we therefore need to think about, and potentially adjust the figures for, "cut off" issues, for example:
- income earned in the period that hasn't yet been invoiced to customers
- income invoiced in the period that hasn't yet been earned
- expenses incurred in the period that haven't yet been invoiced to the business
- expense invoices/ payments in the period for benefits that extend beyond the period end
- the effect of stock movements around the period end
Although these concepts may be regarded as part of the accountant's "black art", the truth is they are very important in making sure the accounts reflect what is actually going on in economic terms, rather than some alternate reality (aka nonsense).
Remedy: consider the impact of cut-off and ask your accountant for advice if unsure.
Not adjusting for movements in stock and work in progress
Businesses whose stock fluctuates significantly from one period to the next need to make sure the management accounts take into account those movements. Without doing so, the cost of sales and gross profit information presented in management accounts may be very misleading.
Remedy: include significant stock movements in the periodic management accounts.
Not posting depreciation
In asset-intensive businesses, depreciation will often be a significant cost component in the statutory accounts. If the objective is to produce management accounts which are broadly in line with the year-end, statutory accounts, then depreciation should be accounted for in-year. For example, if the owner wants to work out how much dividend can be paid out without exhausting reserves, depreciation (as well as other things like corporation tax) must be factored in.
Remedy: include depreciation provisions/ charges in the management accounts; these may be based on the details in the business's fixed asset register (if you or your accountant maintains one).
We sometimes see businesses posting supplier invoices into the purchase ledger; then, when the invoice is subsequently paid, the payment is posted straight to the P&L account. If the business is VAT registered and working on the invoice basis, this may result in input VAT being overclaimed (as well as making the management accounts incorrect!).
Remedy: ensure that invoice payments are posted against the relevant supplier invoice, instead of being posted directly to the P&L.
Tip: periodic reviews of the aged creditors report can point to a problem in this area - if the report contains loads of old creditor balances that you think have been paid, then it usually points to one of two things, either the payment has been posted straight to P&L; or the supplier was paid by the owner, or perhaps in cash (instead of from the business's bank account).
Not operating basic financial controls properly
Reconciling the bank account and other key control accounts (wages, PAYE, pension, VAT) periodically - and following up and resolving any problems - is a basic financial discipline that all bookkeepers should master. It may seem boring, but it's important because it gives the business owner a degree of comfort that the information coming out of the system is reliable and not garbage. It may also help reduce the risk of fraud, especially if more than one person is involved in the process or the business owner is overseeing the process.
Remedy: regularly reconcile all key control accounts and investigate and resolve any discrepancies on a timely basis. If you don't know how to do this, ask your accountant for help.
Scholes CA offers comprehensive programmes of training and support to small businesses who may need assistance with producing regular, reliable management accounts. Check out our full list of services.
Contact us today for assistance.