Importance of Proper Management Accounting & Reporting ©️2022 Logic Figures Pty Ltd. All Rights Reserved

One of the things we notice frequently when working with clients is how often companies misalign their vision, mission, and strategic goals with their finances and accounts.

What do we mean by this?

Often, business owners and leaders have a clear perception of who they are, where they are coming from, and what they want to achieve in the long term. 

Most times all backed by a sense of pride and understanding that despite numerous challenges and highs and lows they are still in the game. They can clearly articulate why their company is special, what makes them stand out from the crowd, and more often than not realise what success looks like for them and their industry. They can describe what a “normal” size project is, what margins are acceptable in the industry and what they expect to see in their business, what their competitors do better, what obstacles they’ve overcome and what they’ve implemented, and so on.

However, when looking at their financial accounts, you cannot wrap your head around those figures and do not know whether you are looking at the same company or not.

There is a clear disconnect from articulating the vision, path, strategy, goals, and understanding of execution versus what you actually see in the books. 

We often see things like:

  • Costs of goods sold (COS or COGS) are all lumped into one bucket, and you cannot report per project. Then how would you know where you make money, what jobs you should pull out from, increase prices, or change strategies?
  • Labour is not allocated against individual jobs. How can you manage projects then? How do you know who’s worked on what and for how long? What about utilisation? Labour and maybe other assets? (We do see the same for equipment, machinery, or trucks, or whatnot). Once bought they sit in property plant and equipment – if not 100% expensed, but certainly not allocated to jobs most of the time as part of the COS. Remember, you bought them so you have a capital cost, so you want to understand what your assumed ROI vs actual return on investment is.
  • Some expenses are erroneously applied to COS. This means that your gross margin will either be lower than expected or higher if not all costs are allocated to a job.
  • No Work in Progress (WIP) and/ or Inventory system
  • If there is no proper WIP, every month costs go against job(s) even if revenue is nil (to compensate for this, there are companies that do % complete instead of revenue recognition against milestones as per Incoterms. We strongly caution against such practice unless you are a property developer or more generally building roads, bridges, apartments, etc. The reason being your cash will not match the profits reported. Be cautious of any of your Directors or Advisors suggesting such reporting. More often than not it is all about trying to protect their own job as it makes them look good even if the performance of the business is actually poor. Eventually, it catches up with you. Remember Enron?)
  • WIP left in the balance sheet, and not expensed against a job for 3, 6, and sometimes even (!) 12 months or more. This creates the impression that you have a higher profit than the business generates and the free cash and profit start diverging.
  • Inventory sits idle as a lump sum or if moved, is 100% expensed against one only job, even if just a small portion is used, and the rest sits on the shelf with zero value. This leads to a devaluation of your business. If you want to sell tomorrow, whatever the value someone will offer for your business will discount with the value of your inventory as assessed by a specialist.
  • Shipping costs are misallocated or randomly expensed against jobs. This creates a problem with standard costs and how to price or estimate jobs.
  • No provision for warranty. There could be hidden costs, and the profitability can look higher than actual if you have returns.
  • As per the new taxation rules, people now can 100% expense on capital asset purchases, and they use only one set of accounts (their tax accounts) as a way to manage their business. That is erroneous because cash doesn’t track the balance sheet anymore nor the P&L.
  • No provision for annual leave and long service leave. This leaves the company guessing its future cash flow balance and commitments.
  • IP is not properly calculated and reported in the Balance Sheet. That devalues your company.

So, what should you do? What would we recommend in these instances?

Well, first you should always start by understanding your business, what market(s) you’re in and you should have very clear financial goals set in your strategic plan.

Your goals should reflect expected revenue, percentage gross margin, cost of sales per job/project/product/service, percentage labour utilisation (and asset utilisation if that’s the case). The expected revenue should be based on data (market intelligence, past performance, CRM, etc) and strategic initiatives that are directed to drive growth: either market share acquisition or increase in profitability.

Then we always look at the existing Org Chart and what the actual Org Chart should look like, in order to deliver those financial goals.

Once we understand these perspectives, what departments the business should have to develop on the path that it had set to, then we look at the chart of accounts.

The chart of accounts should always reflect what the business looks like now and will look like in the future. That is very important and should be set by the company’s accountant/ account manager as approved by the Board. It should not be changed on a whim by whoever does the books. No accounts should be added unless prior approval is given and if it makes sense /it aligns with the business and how that business normally operates. If there are one-offs, then they have to be incorporated into a separate expense or income account and reported in a normalised form.

Concluding:

  • Create the proper Chart of Accounts that properly reflect the business and the activities that you are likely to undertake. If too many legacy accounts with residual (small) values there, call for a Board of Directors resolution to clean up the Balance Sheet, revalue assets and clean the rest of the accounts.
  • Create a system where you have weekly timesheets for all your personnel and (if applicable) for all your assets. Timesheets per job, normal hours only (if salaried). Overtime and double-time are treated differently. This will be covered separately.
  • There are many apps out there available for Quickbooks, Xero, MYOB, etc that enable you to properly track timesheets for everyone. Such functionality is native for any semi-decent ERP.
  • Same with personnel expenses per job(s). Not lump sum. But per job. Weekly. Reconcile, reconcile, reconcile. All against jobs. Same with credit cards (company or individual). See above. There are apps that cover these too. All you need is to take a picture of a receipt and put it against a job. 30 seconds maximum.
  • Make sure that you have all costs per job in before closing a job. If commissioning is involved, allow for 10%-20% of the value of the job to stay in WIP, and continue expenses there until job finished, then expense from Balance Sheet to P&L.
  • Have (at least) WIP properly set up in the Balance Sheet. Ideally, Inventory too.
  • Make sure that you have at least 80% of your WIP expensed against a job before commissioning happens (sometimes it takes months or even years until commissioning is complete; especially in this market)
  • Shipping costs are per the incoterms agreed with the supplier(s) and customers. For example, if shipping is with both ex-works, then shipping from the supplier goes into the COS, while shipping for the client is his responsibility and should be charged separately as a different income line (should that customer ask you to help in that regard). Nevertheless, revenue should be booked ex-works (for that project), and freight (separately) when goods are delivered.
  • It is advisable to allow for something like 2-3% provision of warranty to cover any impairment costs during that period (more for start-ups and less for more established businesses and mature products).
  • Although software like Xero has two ways to deal with depreciation (tax and book depreciation), if that option is not available for your business, then you have to run two different sets of accounts: one tax accounts and one management accounts (the latter will give you a clear reflection of where your balance sheet and P&L align with your free cash flow)
  • Always have a provision for annual leave and long service leave. That’s not your money. It is your employees’ entitlements
  • The “D” part from R&D (development and creation of a prototype) should be part of your intangible assets in your balance sheet. That creates value for the shareholders, should they choose to sell the business down the track. Do not 100% expense these assets. Just do normal amortisation and depreciation for the life of that asset (say, 20 years if it has a provisional patent)

Accurate financial reporting provides management with historical business performance information that coupled with information flowing from forward planning data (such as CRMs), allows for better budgeting and scenario planning

Importance of Proper Management Accounting & Reporting ©️2022 Logic Figures Pty Ltd. All Rights Reserved

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