3 December 2018
Many business owners regard ‘doing the numbers’ as an essential chore. But what if you could use the data generated by your accounting function as a tool to grow your business?
Why grow?
For most entrepreneurs, growth is a given. There may be an underlying plan, to pass the business on to the children, to sell it and retire on the proceeds, to reinvest, or just to satisfy an ambition. However, there is another fundamental imperative: businesses that grow tend to be much more interesting to work in, they continually set new challenges, opportunities for innovation, incentives for promotion, and make it easier to recruit and retain good people. They are also more adaptable and more resilient.
Management accounts
So, assuming you have decided to grow your business, what financial information do you need in order to set targets and measure actual performance against them? In our blog of 28 August, we described the advantages of management accounts. Typically, these are produced monthly by computer and can be tailored to provide easily understood data on the business’s performance within days of the month-end. Cloud accounting in particular facilitates the production of reports on any aspect of the business, with key ratios, trends, comparisons with budget or with previous actual figures, graphs, bar charts, and automatic alerts of important variances. The key is to identify the data that is important to your business and to your growth plan and to design reports that highlight these factors.
The top line
If we look first at the trading account, there are three essential figures: turnover (the ‘top line’); net profit (the ‘bottom line’); and between the two (gross profit).
For most businesses, growth means improving the top line. This figure is the total value of goods and services delivered to your customers during a given period. For any single product, the sales value is the number of units multiplied by the selling price. It is fair to assume that your growth plan will involve increasing the number of units sold. This can be done by selling more to existing customers or by obtaining new customers. Either way, it should involve adding new products to your range, and these new customers and products will have incurred development and marketing costs. Your accounting function should analyse turnover by product and by customer, highlighting the incremental sales by identifying the sales of new products and those to new customers.
Gross profit
The gross profit (or contribution) is extremely important. There is no point in growing the top line if your new sales don’t make a contribution to the bottom line. The gross profit tells you what you have made on your sales, after taking into account all the costs that are directly incurred in achieving them. These are the costs that are not fixed but that vary according to the turnover. In a manufacturing business, for example, they are the cost of materials, outwork, labour, repairs to plant and machinery, transport and delivery. In a catering or retail business they are the costs of goods bought in and those of the staff who prepare those goods and serve your customers. Normally gross profit is expressed as a percentage of turnover and it varies widely from industry to industry. You will almost certainly have a target gross margin for the business as a whole, but is your financial reporting system sufficiently sophisticated to identify contribution by product, or even by customer?
All entrepreneurs appreciate that the price of their product or service is determined by the market, not by the costs of producing it. So, the gross profit analysis will drive efficiency, productivity and innovation. It will indicate where efforts need to be focussed in order to cut the costs of production. These could include better design to reduce waste or to trim labour costs; they might include improving the quality of the product to gain an advantage over your competitors.
The bottom line
Gross profit is the contribution your output makes towards fixed overheads and profit. In order to break even, the contribution has to at least cover the overheads, and net profit is the amount by which it exceeds overheads. So, to grow the bottom line you need to improve the gross profit and keep the overheads under control. Here again your accounting function should produce timely information to highlight areas where more control is needed. As a rule of thumb, you should concentrate mostly on maximising the gross profit. Don’t spend so much time on the overheads unless your monthly reports show major increases in certain costs.
Keep an eye on the cash
The balance sheet deserves more attention than this short blog allows. Briefly, though, watch the cash! Growing businesses absorb increasing amounts of working capital because with more sales comes more stock and more debtors. Stock and debtors take time to convert to cash, so they put pressure on the cash flow. Your cloud accounting reports will probably include a cash flow statement. They should also include key data on debtor and creditor days, liquidity ratios, stock-turn and whatever factors are appropriate for your particular business.
Talk to us
With our extensive and in-depth knowledge of many businesses, UHY Torgersens are indispensable advisers for businesses that aim to grow, and we are experts in the use of financial reporting systems to design realistic targets and to measure performance. Please do not hesitate to get in touch.
As one of the leading firms of accountants in the North East, with offices in Newcastle, Sunderland and Jarrow, we have the expertise to advise you on a wide range of tax-related issues. If you would like to speak to one of our local experts, please contact us.
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