Why is Management Accounting Important?

Why is Management Accounting Important?

I’m lucky enough today to have a guest post from my friend and the management accounting expert to my business, Ben Didier. Rather than spoil the show, I’ll let his post do the talking.

Can we afford it?

One of the biggest jumps that often shock people when moving from employed work to running a business, is the shift in thinking about spending.  In everyday life if we want something; an ipad, a new TV, a holiday, then we look in the bank; if you have the money then you can, if you don’t then you can’t – simple (or you can borrow or save up).

Spending in business works in a fundamentally different way, it is not about what you want, it is about what that spend will give back financially. What is the Return on Investment (ROI)?

The business owner or director may often ask finance: Can we afford a new sales person?   I would advocate looking at the situation in a slightly different way and ask:

“What do we need to do to be able to take on a sales person?”

If a new sales person can bring in more than they cost each month (to be fulfilled by the existing team) then yes, it’s a good move.

In practice there is more to it; sales people generally take a few months to build up a pipeline of work so the business effectively pays the salary for no return at the start.  Then there are additional cost of travel, communications and IT, not to mention the extra delivery capacity required if none is spare.

It many not be more sales directly, perhaps better IT or a new administrator means you can turn out more work in a month.

If for every pound you spend on marketing you get back two pounds of additional gross profit (income after raw materials) then that is money well spend.  Contrastingly buying a gold-plated chair for your office because you like it, is not going to pay you back much.

The fun part look looking at projections – amounts and time scales.  If you need an extra £5k per month in sales to cover costs of a new sales person, then you need to ask some questions:

Can your business handle the extra work?
How many more production people would you need?
How long would it take to build up to that level of extra sales?
Can you fulfil it with your current equipment and office space?
Is there the cash in the bank to pay the salary for 3 months with no additional sales?
At what point do you expect to break-even?

Ask yourself “What if…”

If your top current salesperson finds 5 new clients per month, then expecting a new employee to get 10 per month would be ambitions, but 2 per month should be easy.  That is the kind of situation-modelling that can help shape your expectations, allow you to take considered risks, and monitor progress in an informed way once you have made that investment.

It doesn’t always work out, but if you have thought through the risks, then at least you know the company can still continue if it doesn’t.

Benjamin Didier
Exeter Commercial Accounting

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  • Jamie Banks

    Ben’s article is spot-on! All he has said is perceptive and accurate but, although an excellent case is made out for predicting cash movements and conducting sensitivity analyses (i.e. ‘what if’ scenarios), there is no specific mention of cash flow forecasts as vitally important management accounting tools. I think however, that it’s implicit in the points which have been made.
    Businesses need to know about return on investment, break-even points, profit and loss, and balance sheets, but if they run out of cash they go out of business, no matter how profitable they may be on paper.
    The strain on growing businesses is almost always much greater than on mature ones, and it goes without saying that small businesses tend to be more vulnerable to market shocks than larger ones. Both of these factors make it particularly important that they have a clear, regular and reasonably frequently re-assessed picture of cash flows, so that the cash movement consequences of any future developments or action they may be considering, even if it’s no action at all, can be predicted. A well constructed cash flow forecast should do just that, and will help to ensure that potential pitfalls of the sort to which Ben has drawn attention do not trip up unwitting entrepreneurs. I hope that Ben will agree with me, in principle, and I have little doubt that he could provide a useful service for anyone who would like a version of this management tool created for their business!

    • banksy6

      Thanks Jamie, great point. As you well know, I’m a big fan of the Cash Flow Forecast thanks to your advice over the years :)

  • Ben Didier

    Thanks Jamie, you make a great point, cash is what allows a business to be there so that it even has the chance to provide a great service. With a lead time of a few months on a sale, some weeks to provide the service and then perhapse 30 days for the customer to pay, that is a long time to be paying rent and staff before you receive the return, and as you say, even if it looks good on paper if there is not the cash flow to make it work, then they go out of business. Small changes such as project stage payments, closer attention to debtors and different terms of credit can often help. One of the shocks that you raise could be a customer going out of business before paying a debt, unfortnately it happens, and as you say, small businesses are often more exposed to such events. The importance of cash can’t be emphasised enough so thanks again for your point.