Which Numbers Should I Look at in My Management Accounts?

We prepare monthly management accounts for a number of our business clients.

And something I’ve noticed over the years is that even some very successful business owners struggle to understand a traditional set of accounts.

There’s nothing unusual about that.

You didn’t start your business because you wanted to become an accountant.

A detailed profit and loss account and balance sheet might contain dozens of numbers. Modern accounting software such as Xero and QuickBooks can produce even more reports at the touch of a button.

The problem isn’t usually a lack of information.

It’s knowing which information actually matters.

My advice to business owners who find management accounts difficult to understand is simple:

Start with five or six key numbers.

Once you understand those, you can start digging into the detail.

1. Sales

Let’s start with the obvious one.

How much are you selling?

Most business owners know their turnover, but the important thing is to look at it in context.

How does this month’s sales figure compare with:

• Last month?

• The same month last year?

• Your budget?

• Your forecast?

You also need to understand what’s driving any change.

If sales have increased by 20%, why?

Is it because you’ve gained more customers? Increased your prices? Sold more to existing customers?

Equally, if sales are falling, you want to know about it quickly.

Turnover isn’t everything, but it’s usually one of the first numbers I’d look at.

2. Gross Margin

Increasing sales is great.

But how much are you making from those sales?

That’s where gross margin becomes important.

If you sell £100 of product or services and it costs you £60 directly to deliver them, your gross profit is £40 and your gross margin is 40%.

A business can increase its turnover while its gross margin deteriorates.

That’s not necessarily good growth.

Perhaps material costs have increased.

Perhaps you’ve discounted too heavily.

Perhaps labour costs on jobs have risen.

Perhaps there’s excessive wastage.

This is particularly important in industries such as hospitality and construction, where relatively small movements in margin can have a substantial effect on overall profitability.

Don’t just ask whether sales are increasing.

Ask:

“Are we making enough money from those sales?”

3. Net Profit or EBITDA

Next, you need to know what you’re actually making after the costs of running the business.

Depending on the type and size of business, I might look at net profit or EBITDA.

EBITDA stands for earnings before interest, tax, depreciation and amortisation.

Don’t get too hung up on the terminology.

The important point for a business owner is to have a consistent measure that tells you how profitable the underlying business is.

Again, don’t just look at the number in isolation.

Compare it with previous periods and your budget.

If turnover has increased substantially but profit hasn’t, you need to understand why.

4. Cash

Here’s where things often become confusing.

Profit isn’t the same as cash.

You might have made a £50,000 profit, but that doesn’t mean there will be an additional £50,000 sitting in your bank account.

Some of your profit might be tied up in customer debts.

You may have purchased equipment.

You may have increased your stock.

You may have repaid borrowing.

This is why I’d always want a business owner to understand the company’s cash position as well as its profitability.

How much cash do you have?

What payments are coming up?

What cash do you expect to receive?

And, importantly, what will your cash position look like over the next few months?

A cash-flow forecast can often be more useful than simply looking at today’s bank balance.

5. Where Has the Profit Gone?

This follows directly from the previous point.

If your management accounts say you’ve made £100,000 but you can’t see £100,000 in the bank, you should be able to understand where it has gone.

A cash flow statement can help reconcile the difference between your accounting profit and the movement in cash.

Perhaps £30,000 is sitting in unpaid customer invoices.

Perhaps £20,000 has been spent on equipment.

Perhaps you’ve increased stock by £15,000.

Perhaps you’ve repaid £10,000 of borrowing.

Once it’s explained properly, the difference between profit and cash usually becomes much easier to understand.

For me, this is an important part of good management reporting.

Don’t just tell a business owner what profit they’ve made. Explain what’s happened to the money.

6. Debtor Days

If you invoice customers rather than being paid immediately, I’d also look at debtor days.

Debtor days broadly tells you how quickly your customers are paying you.

You can have a very profitable business on paper but still have cash-flow problems if customers aren’t paying.

Suppose your normal payment terms are 30 days but your average debtor days have increased to 60.

That’s something management needs to investigate.

Why are customers taking longer to pay?

Is credit control being done properly?

Are particular customers causing the problem?

As a business grows, poor credit control can absorb an enormous amount of cash.

So don’t just concentrate on winning sales.

Make sure you’re collecting the money as well.

You Don’t Need to Become an Accountant

This is the important point.

I don’t think a busy business owner needs to understand every line of a detailed profit and loss account or balance sheet.

That’s what your finance team and accountant are there for.

But I do think you should understand the key numbers that drive your business.

For many businesses, I’d start with:

Sales

Gross margin

Net profit or EBITDA

Cash position and cash-flow forecast

Profit-to-cash reconciliation

Debtor days

Your particular business may have other KPIs that are equally important.

A restaurant might concentrate heavily on food and drink margins.

A construction company might focus on work in progress and individual contract margins.

A professional services firm might monitor staff utilisation and recovery rates.

The precise KPIs will depend on the business.

But you don’t need 50 of them.

Management Accounts Should Be Explained

Accounting software has changed enormously.

Provided the bookkeeping is accurate and up to date, much of the process of producing monthly reports can now be automated.

That’s useful.

But pressing a button and producing a 20-page management accounts pack isn’t the same as providing useful management information.

Somebody still needs to interpret the numbers.

When we prepare formal monthly management accounts for clients, the commentary and discussion around the numbers can be just as important as the reports themselves.

Why has the margin changed?

Why is cash down?

Why have debtor days increased?

Why is profit ahead of budget?

Those are the questions that turn accounting information into useful business information.

The Bottom Line

If you struggle to understand your management accounts, don’t try to master everything at once.

Start with the handful of numbers that really matter.

For many businesses, that’s sales, gross margin, profit, cash flow and debtor days.

Understand what those numbers mean.

Compare them from month to month.

Look for trends.

And when something changes significantly, ask why.

Once you’re comfortable with those key numbers, you can gradually go deeper into the accounts.

Good management accounts shouldn’t make running your business more complicated. They should make it easier to understand.