In this guide, we take a look at the differences between financial and management accounts, and how each type of accounts can benefit your business.
Running your own business seems to be as much about playing with figures as it does doing whatever you got into business to do!
There are annual returns to generate, corporate tax returns to fill out, PAYE, VAT… it can all be a little overwhelming, even when you have an accountant to steer you through the maze.
Just to add to the fun, you can prepare regular management accounts. Management accounts are not required by the government or the taxman but they can be a very useful tool to help you to keep a handle on how your business is performing.
So what are the differences between management and financial accounts?
The financial accounts are required by law and describe how your business has performed over the last year. The information in these accounts will be used by external bodies that have an interest in knowing about your business, such as Her Majesty’s Revenue & Customs (HMRC), any investors and your bank.
Financial accounts are typically made up of three elements:
Profit and loss account: A summary of business transactions for the last 12 months, which shows whether the business made a profit or loss
Balance sheet: A snapshot of the business’s financial health on a particular date. It shows the assets the business owns and financial liabilities. Essentially the balance sheet shows whether the business is solvent or not – does it have enough assets (including cash) to cover its liabilities?
Cash flow analysis: This examines whether there is enough cash coming in to cover the business’s outgoings. Many businesses that fail simply run out of cash, despite having healthy sales.
Management accounts are a little different. They are a set of figures looking at areas of your business, that are just for you and your management team.
They can be used by both limited companies and people working as sole traders. Although there is no legal requirement to produce them, many businesses do on a monthly or quarterly basis. In fact, once your business is bigger than one or two people, you will need them to keep track of what’s actually happening.
Most people use their management accounts to see how their business has been performing in many different areas. That then helps them make timely sensible decisions based on accurate information.
In the management accounts, there should be data on the following areas:
Sales: The performance over the last month or quarter, product pricing and credit control (how much you are owed)
Purchasing: How much your business has spent in the last period, how much stock it holds and what you owe
Fixed assets: What your business owns, for example in equipment or vehicles
This information shouldn’t just be another historical document; it should be focused on looking forward to provide useful analysis for the future.
For example, you can use your management accounts to look at your sales revenue, when it is due in, and which of your customers are likely to pay late. This is a powerful way to accurately predict what your cash flow will be like in a few months’ time, giving you plenty of warning that you may need to arrange some temporary finance.
You can also spot worrying trends, such as stock levels increasing against flat sales (again a sign that you’re heading for cash flow problems). Or that your sales in a particular product are slightly down several quarters in a row. This kind of advanced warning can help you create new products in time to replace waning demand.
If you’re not currently using management accounts, speak to your accountant or bookkeeper today. The information you glean could make a significant difference to the future of your business.
Remember to get professional advice from a qualified person before taking any action. Don’t rely purely on information contained in this article.