What have waves at the beach got to do with the profitability of your business?
Well it turns out there are some remarkable similarities which can give you a valuable insight into running your business.
Imagine sitting on a beach watching waves washing in and out. Some are large and come right up the beach, others are small or even cancel out with water washing back down the beach. Then sometimes the water goes way out and you’ve got this large stretch of sand in front of you, then seconds later, the water is back.
Well the cash in your businesses’ bank account is very much like the waves on the beach. It washes in and out – sometimes alarmingly – but always in motion.
Now try to work out if the tide is coming in or out. You can’t, can you? You have to wait hours before you can be certain of which way the tide is going. Profit is a bit like the tide, it’s often really hard to tell if you’re making a profit or not, especially if you sell product and have changing stock levels, or you sell large service projects spanning multiple months, or both.
The danger is obvious. By the time you work out that you’re unprofitable (tide going out) it is very late to be taking action – possibly too late as it is for so many businesses every year.
So what if you don’t know that you’re in losses? Well there are two dangers. Firstly, you can lose the business which is sad enough for you and your staff. But it doesn’t end there. An administrator or liquidator may get appointed who will crunch the numbers, work out how long ago you couldn’t pay your bills, and your personal assets (read “your house”) are now at risk of being sold to repay creditors.
Fortunately, there is an answer to the problem. It’s called “accrual accounting” which is wrapped up in proper “management accounting”. This type of accounting removes the waves so that you can see the tide coming in (or not) immediately. Most public practice accountants just do tax accounting – which relies on accrual accounting, but only calculates the annual totals – far too late to help the business owner.
You need an accountant that can do Management Accounting, because done properly, it gives the business owner a monthly set of reports which shows “profit”, which is how much you made, and when you made it. Cash is all over the place like the waves. Profit is like the rising tide and ultimately becomes cash in your pocket (or pays down debt). Importantly, if you know you’re making a profit, you know the cash is coming.
The benefits keep coming. Once you see how much real profit you are making, you also get an insight into just how your business makes money. Now you can make adjustments, tweaks and corrections to increase that profit.
So how do you take advantage or Management Accounting? Firstly you need an accounting service who can prepare the reports for you (or help you prepare them), and then you need to read and understand them. Tactica Partners prepares Management Accounts for clients who ask for them, and if you feel you’d benefit from some training in interpreting your management accounts, we can help there too. Please call our office on 9387 5637.
