SMEs need to make better use of their year-end account management figures, as annual accounts act as the most honest critic of a business’ success.
According to HLB Mann Judd Sydney partner Simon James, business owners should review their annual results to better understand the business how it could be made more profitable.
“End of year accounts deal with what actually happened, not what might have happened, or what someone else thinks did happen, or indeed hoped would happen.”
He stresses the importance of knowing how financially sound your business is, saying too many business owners rely on others do to the work while they turn a blind eye.
“Those that are on top of their financial reports are also more likely to take early correcting action to resolve emerging problem areas so that they are more likely to survive any economic downturn.”
James said business should satisfy themselves over five basic areas:
1. Check profit
This is a critical comparison every year. How does the profit compare with the year before? Is it in line with what was expected? If not, look at the total income to see if there is a big difference from the year before. If income has dropped in an unexpected way, find out why. Which customers are buying more or less and what is the reason for this trend?
If income hasn’t varied significantly from the previous year and is in line with expectations, any profit fall must be because of increased operating costs and the owner needs to check expenses.
2. Growing areas of cost
Rather than analysing each expense item, a better approach is to look at anomalies or exceptions. For example, if “cost of entertaining” has risen dramatically over the previous year, ask why. Are there good reasons for it or is it an area where more control is needed? Looking at changes in costs year-by-year can be a very good reality check – and all increases in expenses will have impacted on profitability.
By taking this approach, the reasons for any significant difference between last year’s profit and the previous year can be identified, and strategies to correct any problem areas implemented.
3. Source of funds
This area of a balance sheet can take a bit of understanding, but it’s worthwhile for business owners to know where the funds that run the business are coming from – and what they cost. If there has been an unexpected increase in borrowings, find out why and try to take correcting action.
The best source of funds is always from sales but if the debtors’ list is getting longer, it means the business is providing cheap funds to customers, which means their own cost of funds through borrowings is likely to be growing.
Problems with the source of funds and having sufficient liquidity is often an early warning sign that not enough sales are being made to cover operating costs, that profit margins are not good enough, that there are unnecessary costs, or that there are potential bad debts.
4. Debtors
All business owners and managers should be keeping an eye on debtors in the current trading conditions. If not already in place, make sure that current debtor reports are provided regularly so the aging of debtors can be monitored. Prompt action must be taken on any slow paying or, even worse, non-paying customers.
Continuing to supply non-paying customers is almost certainly throwing good money after bad no matter how important the customer is. Bad debts are a loss of capital and a drain on liquidity and can send a company out of business.
5. Inventory
This is another area for potential problems that’s often overlooked or not recognised. Rising inventory levels could mean sales in some lines are slowing or that over-ordering is taking place.
In either case it means capital is being tied up unnecessarily and that there is increased potential for obsolete, and perhaps unsuitable, lines being held. Investigate stock levels and try to liquidate old or unwanted lines.
Inventory is also an area of potential fraud – purchasing goods through dummy companies that are not delivered, in addition to theft, is a common feature of ongoing fraud in a business.
