Management Accounting Suggestions
In this article, we discuss some of the common improvements that can be made to small business management accounting bookkeeping systems to make them more useful for management accounting and performance measurement purposes.
The usefulness of many of the tools and discussions in 12Faces rely on the quality and nature of the small business management accounting data being input and relied upon.
These suggestions are general in nature and may not suit your specific circumstances. For taxation purposes, and whenever uncertain, you should seek advice from a relevant professional
Accrual Accounting for Business Performance Monitoring
The majority of smaller businesses run their accounting on a “cash” basis. They use their bank statements to record the flow of cash into and out of their business.
This is easier and faster but less helpful when you want to analyse your business’s performance. With cash accounting, you are always working in the past; when the money came and went. You have no window into the future income and expenditure.
Larger businesses, and those that want to get the most performance information out of their accounting records, use “Accrual” accounting.
Simply put, businesses that use accrual accounting recognise income as soon as they raise an invoice for a customer. And when a bill comes in, it’s recognised as an expense even if payment won’t be made for another 30 days. So it ‘accrues’ at some future date.
Its a bit more cumbersome but much more informative. Until you have accrual accounts, your ability to measure cashflow, work in progress, inventory and predict profits and losses is impaired.
All quality bookkeeping packages allow you to de accrual accounting.
Some specific suggestions follow.
Invoicing your clients
You should construct an invoice for your clients as soon as possible in the accounting workflow even if you don’t send it out for some time or put a long payment period on it.
This gives you far better measurement of future income.
This is particularly the case for ‘project’ based industries like e.g. construction, manufacture to order, architects where they do specific projects for clients.
It is less relevant to e.g. retail, ecommerce and hospitality where often payments are made ‘over the counter’ and immediately.
If you are paid in instalments, you can prepare several invoices at the time you take the order; one for each instalment. Any changes along the way can be reflected in alterations to the invoices.
This gives you a better view of the inbound cashflow into the future.
These are bills you have to pay.
Best practice is to enter them into your accounting systems as soon as possible after receipt; even if you don’t plan to actually pay them for some time.
This will always give you a better picture of the outbound cashflow into the future.
You will have a number of bills you only pay once a year e.g. insurance, tax accounting, annual registration fees on vehicles.
In purist accrual terms, you should spread these over 12 months in your books. It is up to you if you do this but we consider it unlikely to be necessary unless there are very large annual fees that will distort the results in the particular month they are due for payment.
Google will show many results and probably for your specific accounting system.
- Xero video on how to do
- Quickbooks on “what’s best for your small business”
- Freshbooks on the differences
- Zoho on the differences
Management Accounting for Inventory
Many businesses do not make much use of inventory. Examples include many service industries. They probably don’t need much sophistication recording inventory in their accounting system.
Others make extensive use of inventory e.g. wholesale and retail, manufacturing. Not having a good accounting system for inventory means they can not take advantage of a host of inventory performance monitoring tools and so do not get a warning when their inventory systems are deteriorating. If this is you, read on.
Inventory Accounting Goals
For useful inventory performance monitoring, we need an opening and closing inventory valuation. There are several ways of calculating this.
Depending on the nature of your business, you may have up to three types of inventory you wish to monitor separately;
- raw materials: the components a manufactory coverts into finished goods
- work-in-progress: partly assembled products for future sales and
- finished goods: products ready for sale
Inventory Management Systems
If you are an inventory-intensive industry, at some point an inventory management system becomes important for accurate accounting and, equally important, to ensure you are not over or under stocked in inventory items.
These often have a POS module for accurate tracking and will certainly give an opening and closing inventory balance.
How to Calculate Closing Inventory Balance
if you don’t need an inventory management system, you can estimate inventory flows with several rules of thumb:
- if you mark everything up by a standard percentage, you can estimate the value of inventory sold by reversing the markup. Say you mark up by 50%. An item that costs you $100 will be sold by you for $150. Therefore, if your sales are $15,000, you have sold ($15,000 *100/150) = $10,000 of product.
- you can also work from your Gross Margin%
- for more, see e.g this Freshbook’s reference
For more on the entries to be made in your accounting system, for the various types of inventory, read the following references. Or Google the topic for your specific accounting system: