The Finance Interim Elves have been working hard to bring you what you want for Christmas!!
Is 2021 the year?
If you are looking to better understand which customers make or lose you money, which products are most profitable or where you can improve efficiency, then you need better information.
Putting tools in place to extract and visualise your data to drive improvements in your business.
“There comes a point in most companies growth journeys where it makes sense to appoint someone to help with the growing complexities of financially managing a bigger business. This is especially important now in the light of growing uncertainty because of the Covid 19 pandemic and Brexit.”
I am still surprised at the number of SME’s who don’t get accurate monthly management accounts within a couple of weeks of the month-end close. I recently heard of a medium size business who was preparing quarterly management accounts!
“But what does it matter if I don’t get the figures for six weeks?” My response to this is that you won’t know how you performed in the first week of August until mid-September. Or in the case of the business above, November or December! This could be too late as you may have been already hit by spiraling costs, excess stocks or too many heads.
I can see that when profits are good and you have money in the bank there is less pressure to invest in better management information. But it can be likened to trying to manage a contract with no feedback on how it is going or if the employees are working efficiently (or at all!). Or indeed running a manufacturing plant without knowing how much you have produced and of what quality. In other words, blindfolded.
Knowing promptly how you are performing is essential as it allows you to make changes to improve the situation quickly. This especially has been seen recently where Covid-19 has meant businesses have needed to respond quickly and become more efficient to survive. Just imagine having to wait for 3 months until you know what impact it has had on your business in order to make changes!
Improving your management information is not difficult, it just needs focus to make the process efficient and fit for purpose. It’s the same as you would do in other areas of your business, you invest time to understand the shortcomings and then make the necessary improvements. A widely experienced specialist can bring different ideas to the table and help the Finance team deliver what the business needs.
In addition, management accounts provide a number of other benefits that include:
1. Encouraging the Finance team to carry out Balance Sheet control reconciliations in a timely manner and thus improve the accuracy of the accounts (and reduce fraud risk).
2. Monitoring how you are performing against budget for the month and year to date.
3. Showing investors that you know what you are doing or are “investor-ready”.
4. Offering an aid for tax and dividend planning.
5. Lowering your annual audit fee as the accounts can be prepared more quickly and efficiently.
As we start to lift our heads above the parapet, now is the perfect time to invest in management information so we remain agile to both challenges and opportunities that arise over the coming months.
Covid-19 has fundamentally reshaped the UK’s economic landscape and there have been many casualties along the way. But now that the initial reaction phase is over, getting back to some sort of ‘business as usual’ offers a new set of challenges.
How can the Finance Director support the SME to get back on its feet?
- Flexibility planning
The budget is out of the window, now is the time to focus on scenarios, what happens if sales half…or double? Understanding your new market place, competitors and consumers is key to the actions that follow on. Then depending on the outcome, look at restructure, operational efficiencies and overhead reductions accordingly. An article I wrote on forecasting could help: https://www.linkedin.com/pulse/5-steps-cash-forecast-heaven-kevin-thomas-aca/
- Improve liquidity
Based on the scenarios look at cashflow requirements. Ensure credit control is functioning effectively, purchase efficiently and work with suppliers to agree terms. The Government is offering a variety of loans, grants and benefits and reliefs, can these be utilised? Revisit financing arrangements, can further cash be drawn down? Or a low interest loan be utilised? I refer to an article I wrote on improving working capital here: https://www.linkedin.com/pulse/6-ways-turn-working-capital-cash-kevin-thomas-aca/
- Managing the Team
With children at home for the next few months, there is likely to be a period of hybrid working with some in the office and some working from home. Ensuring that the teams are working effectively and productively in the period is paramount. Keeping on top of the reporting requirements is essential as is ensuring the health and wellbeing of the team. I wrote an article on ways to avoid zoom fatigue that may help: https://www.linkedin.com/pulse/zoom-fatigue-why-am-i-so-tired-working-from-home-kevin-thomas-aca/
- Stakeholder Communication
Ensuring that the wider business has the right information at the right time to make decisions. Ensuring that investors and lenders are kept in the loop about the business as they may be able to help. Ensure that employees are kept informed to ensure they still feel part of the team even when working remotely. Keep the lines of communication open with the supply chain to anticipate problems in supply, price changes or when customers change their orders.
- Manage risk and build resilience
Revisit your risk model and update with new knowledge as it arises. Your competitors may have adjusted to Covid-19 well and what can you learn from how they have adapted? Look to build resilience into the business, alternative suppliers, new sales channels such as E-Commerce and building an agile workforce. Many businesses have shown great innovation over this period, especially with their use of IT, and this could be the source of differentiation going forward.
Putting these steps in place will not only help you recover and survive from lockdown, but to potentially thrive. As Benjamin Franklin said “Out of adversity comes opportunity.”
I have recently been reminded of a role I had where my predecessor was asked to leave for allowing a financial black hole to develop in the Balance Sheet. Indeed, the reason for a failure at Patisserie Valerie was a focus on the Income Statement which allowed a black hole to develop on the Balance Sheet.
When the primary focus of management is the Income Statement, it is often the case that reconciling the Balance Sheet accounts becomes secondary. My argument is that you cannot rely on accuracy of the Income Statement if you haven’t reconciled the Balance Sheet accounts first.
An example of this is where goods are booked into stock, but what happens if the invoice has not been received at the period end? The key to this is providing an accrual for the amount (“Goods Received Not Invoiced” or “GRNI”). But the only way you can do this is with good systems and knowledge within the accounts team of how it works. This latter point is often where the problem lies, and was the reason my predecessor (who was a qualified accountant!) was asked to leave.
Here is my list of the 6 ways to avoid creating a black hole:
1. Reconcile your bank balances to statements, every period end.
2. Ensure that stock is valued at the lower of cost or net realisable value. In other words, it should be valued at cost unless you expect to receive less for it, then value it lower.
3. Provide for any expense that you have incurred but not charged the period. EG GRNI, fixed asset impairment, obsolete stock, bad debts, sales commissions/bonuses to name a few.
4. Seek third party verification to balance sheet accounts where possible. EG PAYE due to HMRC records, Inter-company balances to the other company, Trade debtors to post-dated remittances/customer verification, accruals to documentation etc
5. Ensure that only true fixed asset costs are capitalised. If costs are later found to be capitalised in error, they will then have to be charged to the income statement.
6. Look for “dangling debits” in the Balance Sheet. These are amounts just lingering on the Balance Sheet in the hope that they won’t be charged to the Income Statement! I have seen many examples over the years, EG Costs incurred that you hope will be covered by suppliers/refunded by customers, cost incurred that you don’t know where they should go in the income statement, suspense accounts, negative balances in trade creditors etc
In summary, the key is ensuring the debits on the Balance Sheet (assets) are legitimate and not overstated and that credits (liabilities) are not understated. Sounds easy! But as systems get more complex and reporting deadlines become tighter, the risk of creating a black hole is increasing.
In January Patisserie Valerie crashed into administration following an investigation into alleged long-term fraud in its accounts. With their accountant saying audits ‘do not look for fraud’, this is a good time to reflect on the strength of internal control in your business and whether your systems would deter, prevent or detect a fraud.
What are Internal controls?
Internal controls are a set of policies and procedures put in place to ensure accounting systems are reliable, fraud risk is minimised and business assets are safeguarded. Without accurate accounting records, managers cannot make fully informed financial decisions and the business can be exposed to fraud. It is a sobering thought that accountants KPMG found that 60% of fraud is committed because a business had weak internal controls.
It can often be the case that in a fast moving business, the policies and procedures are relegated down the list of issues to address because frankly there are more important things to do! However, I would argue that SME’s need to take internal control more seriously, because their losses are less easy to absorb than in a larger business. Furthermore, they are unlikely to have an internal audit function and may not have the benefit of an annual external audit to assess controls.
Accepting SME’s have limited resources, this guide points to the key controls that businesses need to make sure are in place. These can be split into 7 categories:
1. Physical security of assets
2. Standardised procedures
3. Segregation of duties
4. Approval limits/Delegation of authority
5. Double entry bookkeeping
6. Checks and balances
7. Human Resource controls
Physical security of assets
This not only includes CCTV, safes, locks and entry passes, but also data backups. Regular physical audits should be carried out on cash, stock, materials, equipment and tools to check the business actually has these assets and they are recorded correctly in the accounts. Password access to different parts of an accounting system can safeguard information and access logs can keep a record of who accessed what and when.
Standardising procedures hugely reduces the risk of control breakdown. Procedures should be designed with control in mind and any divergence from the standard means control is weakened. Procedures should be audited at least annually to check that it is still best practice and is still operating correctly. They should work very much like quality standards.
Segregation of duties
Segregation of duties involves splitting responsibility between staff so no one person carries out all elements of a transaction. For example, no one person should be able to order and pay for goods or add a fictitious employee to the payroll and then pay them. For small businesses with only one or two accounting employees, control can be achieved by adding manager approval.
Approval limits/Delegation of authority
A requirement for specific managers to authorise certain types or values of transactions can add a layer of control to ensure transactions are seen and approved. Putting a delegation of authority in place gives limits to this authority. For example, an individual can generate purchase orders of up to £500 but requires a manager’s signature up to £5,000 and owner for anything higher.
Double entry bookkeeping
Using a double-entry accounting system adds reliability by ensuring that the books are always balanced. Most systems such as Sage, Xero or SAP will not allow you to post one sided entries, but using a package such as Excel gives poor control. Running a trial balance regularly confirms the system balances and this should be used to prepare MI at least monthly. Actuals should be compared to forecast and authorised by a manager at least monthly.
Checks and balances
Regular accounting reconciliations can ensure that balances in your accounting system match up with balances in accounts held by other entities, such as banks, group companies, HMRC, suppliers and customers. These checks should be carried out at least monthly and in the case of bank reconciliations as frequent as daily. Reconciliations should be checked and authorised by a manager.
Human Resource controls
Having the right staff is critical to control and checks should be made accordingly. Examples include qualifications verification, references and criminal record checks on new recruits. During periodic assessment and appraisals, staff should be assessed for competence and training needs. Staff should be obliged to take holidays and businesses should have a whistleblowing procedure.
Final take away
Remember that the owner’s overall attitude to the importance of internal controls creates the control culture for that business. Setting the right tone ensures that control is taken seriously by employees.
Internal control is a complex area and I have tried to summarise the main areas in this article. If you feel your internal control could be improved then why not get in touch where we can carry out a full review and provide practical recommendations relevant to your business.