It’s that time of year again when we feel obliged to
take an unusually close look at our financial state
ments. Often this leads to confusion and frustration because the numbers don’t relate well to specific activities within the company and don’t readily reveal any critical findings. When this is the case it’s time to step back and look at the books from another level, a level from which you ask not “what do the books say” but instead “what do I want the books to tell me”.
There are three managerial objectives you need to reach with a well designed set of financial records –
Account for the Activities and Decisions Made in the Business. Often a set of accounting records do not facilitate these objectives because they were designed early in the development of the business before the levels of review were fully understood by the manager and bookkeeper or accountant. It may be time to revisit the basic design of your bookkeeping process to see if it adequately fulfills two key accounting objectives – to match each category (account) in the financial statements to specific activities, and to segment financial statements into groups of accounts into that identify individual areas of managerial responsibility or product success.
Analyze the Outcome of These Activities and Decisions. The most common first step taken after receiving a new set of financial statements is to turn to the bottom of the income statement and inspect the net profit figure. The second step is to question why it is what it is, and thus the analysis starts.
The first level of analysis is to look at how effectively areas of the business, and individual activities were managed, by comparing them to an objective. To facilitate this financial statements should be common sized, or presented such that every element of income and expenses are expressed as a percent of total income and every element of the balance sheet are expressed as a percentage of total assets. This facilitates comparing objectives and actuals when the level of total sales and total assets differ from the target totals.
After key accounts are identified that differ from the objective, the second level of analysis is to identify the trend being established. If an expense account is higher than desired and trending to even higher future levels, there is much more reason for alarm than if the trend is toward bringing the expense back to target level.
The third level of analysis that should be regularly undertaken is ratio analysis. In this analysis accounts from the financial statements are combined to assess the level of risk, return, and liquidity in the business compared to industry standards. This comparison of operations to other companies helps a manager assess the competitive position and long term viability of the company.
Project the Consequences of Future Activities and Decisions. To put a spotlight on activities that need critical management attention, it is important to initially project current operations into the future by projecting each income, expense, asset, and liability account separately so that the historic trend in each is allowed to run. This allows the projection to portray what will happen if current practices are allowed to continue. This will draw attention to key areas that need management attention and should prompt an action plan to affect changes that will bring specific accounts (activities) back into the target range. Any successful projection will bring to light the need to plan the three basic components of sustainable growth – cash flow, profit planning, and debt management.
What this article suggests is that a wholesale review of your bookkeeping and financial management procedures may be required to gain the full value from your accounting efforts. While this sounds like a monumental undertaking, it may not be as difficult as it first appears. COCC is offering a ten week course (Accounting Fundamentals – BA 215) that provides the necessary overview of the key points referred to in this article. For additional information call 383-7735.