A few days ago I had a meeting with a client (he had asked Viridity to consult on what systems might be suitable for his business) and his accountant (who had asked to sit in on the meeting as he felt he had something to add to the discussion).

The client was frustrated by the fact that he couldn’t get the information he needed to run his business from the software he was running (no names, this post is not about software per se).  His concerns were mainly around inventory management – he was frequently experiencing stock outs of one product or another, whilst at the same time his overall stock on hand was far higher than he felt it should have been (a point on which all present agreed). 

The accountant put up lots of arguments for why the software in place was “the right solution” – it was easy to use, it was easy to find staff who were familiar with the software, the software was reliable, it offered a “complete range of really good reports”.  This last point though concerned me: it was clear that the accountant’s view of what comprised a complete range of reports was a Profit & Loss and a Balance Sheet (i.e. everything needed to prepare a tax return).  The idea that the client might want to access additional reports that would help to run his business better seemed not to have occurred to the accountant.  I should stress that I know many accountants who would be as horrified as I was by this view!

This experience made me ponder a question: do SMEs in Australia have the financial information they need to improve the performance of their businesses?  This client felt he did not, but I know of far more businesses that do not seem to worry about their financials.  I know this is a very sweeping assertion, but I wanted to put up a number of observations that suggest to me that this is the case.  I would love to be howled down on this topic!

·         Only a minority of businesses routinely run a profit and loss report, and even fewer run a balance sheet.  If these reports are run, it is as part of the process of preparing / lodging the BAS, rather than for the enlightenment of the business owner / manager.

·         Those businesses that do run reports do not routinely have any basis for measuring whether the figures reported are “good” or “bad”.  For example they don’t compare results to a benchmark of other similar businesses, they don’t measure whether the performance is improving or worsening compared to last year.

·         Very few SMEs routinely prepare budgets (compared to large business where well in excess of 90% of organisations budget annually).  The (partial) exception to this in the SME sector is not for profits.

·         In almost 10 years of consulting to SMEs I can count on the fingers of one hand businesses the businesses that have demanded any form of ratio or other financial analysis.

·         Most SME’s do not keep their accounts up to date – they will for example finalise their data entry and their bank rec 2 or 3 months in arrears, so any reports they do run will be so old as to be more or less useless as a basis for making decisions.

I could add lots of other observations that suggest to me that Australian SMEs do not routinely use financial information to make business decisions to improve the performance of their business, but I would prefer to hear some views from other people.  What are your experiences in this area?  Do you routinely run the sort of reports and analysis I have outlined above?  If not why not?

Does it ever seem like the only reason you keep accounts is because the ATO make you?  How about using your accounting information so YOU can see how your business is performing?  It’s really not that difficult to do, and like anything else it gets easier with practice – so let’s start with a few basics.

There are a whole range of reports you can run from your accounting software that will give you important information relating to the performance of you business (and this post assumes you know which reports you want to run, but if you don't we can provide help with that).  Once you have run your reports how do you interpret that information?  How do you know if the figures in the report are "good" or "bad"?

Well there are basically 3 ways to measure an accounting report: you can measure it against a previous period, you can compare it to a budget, or you can measure it against other similar businesses.  Let’s take a look at these 3 options in a bit more detail.

Compare to Another Period.  This is the easiest way to measure your results – you just run the report (for instance a P&L) and select to compare this period to earlier ones (last month, or the same month last year). 

Review the report to see if your results getting better or worse?  Often putting the summary figures into a graph will help as a graph will reveal any trends really clearly.

And identifying the areas that are not trending the way you would like will tell you where to focus your attention to try to improve performance.

But a prior period report isn’t always enough.  What if last year you had an exceptional “one-off” year, and this year you’re still doing well, just not quite as well.  Is the downward trend “bad”?  Or what if your business (or the market you are operating in) is changing?  Then making year on year comparisons is harder.  One of the answers then might be to use a budget.

Compare to Budget.  To do this you will need to sit down and work out a budget – this doesn’t need to be very sophisticated, it is really just a financial plan (but if you’ve not prepared one before it can be pretty daunting).  With June 30^th fast approaching we will be adding a “how to create a budget” post to this blog within the next few weeks, or if you need help on this more urgently please contact Viridity).

Armed with your budget you can report your figures with the budget as the comparison.  You can investigate any differences (or variances as they are sometimes called) – and more importantly you can decide what to do in response.  If you make a habit of doing this every month you will be in far greater control of your business than if you wait for your accountant to tell you your profit figure at the end of the year.

Even a budget may not be a complete answer – maybe you are being unrealistic in setting the budget targets, maybe you could be doing much better.

Comparison to Other (similar) businesses – or “Benchmarking”.  Comparing your business to others can be a great way to measure how you are performing, as you now do get an “objective” yardstick. 

There are companies that sell this information, and it is relatively inexpensive, but if your business is too small to justify the expense there is a free alternative.  The ATO recently released performance benchmarks for 50 different types of business, and you can use this information to measure how your business is performing.  From the many thousands of tax returns lodged with the ATO they are able to assess the “normal” ranges of ratios to sales of cost of goods sold, labour and rent and other expenses.  You can use this data to compare to your business.  You can access the ATO data here. 

One further tool that this post doesn’t cover is using “ratios” to help with interpreting the figures.  So when you have run your report, against whatever comparative you are using, how do you might still need some additional help to spot what is good and what is not.  That is where ratios come in.  But that is also a topic for another post.

If you would like assistance implementing or interpreting your reporting please contact Viridity.