Management Accounting Tips for Small & Medium Businesses (SMEs)

The main focus of this article is to increase the awareness of management accounting techniques among small & medium business owners to help them to grow their businesses more systematically. SMEs are contributing immensely to the Australian economy and their growth is important for sustainable economic growth of the country.

Some of the key benefits of applying management accounting tools & techniques to the business are listed below.

  • Measuring the business performance to see whether the business is growing or not.
  • Proper business planning through effective budgets & forecasts.
  • Implementation of systems & controls to protect the business’s assets & reputation.
  • Ability to make more informed strategic business decisions.
  • Proper cash flow management to achieve sustainable business growth.
  • Accurate product pricing by analyzing true costs.
  • Proper resource allocation to maximize profits.
  • Identification of most profitable customers/products through customer/product profitability analysis.

Large corporations use various management accounting tools & techniques on a day to day basis to improve & measure business performances, make strategic business decisions, implement control systems & processes, etc. They also have qualified & experienced management accounting teams to employ those management accounting techniques.

However, the use of management accounting techniques is very poor among small & medium businesses. Experts in management accounting research (e.g. Nandan, 2010) have suggested that failure or underperformance of small & medium businesses is mainly due to their failure to utilise proper management accounting techniques.

Various management accounting tools & techniques are available for small & medium businesses. Some of the tools & techniques and their benefits are listed below.

  • Product Costing – Helps to identify the true cost of a product or service.
  • Cost-Volume-Profit (Breakeven) Analysis – Helps to identify how changes in cost and volumes affect the profitability. It also helps to make better decisions regarding production levels, pricing & costs.
  • Budgets & Forecasts – Useful planning & control tool. Helps to stay focus on achieving the objectives.
  • Variance Analysis – Helps to identify the changes in the business operations compared to the previous periods and/or budgets.
  • Performance Measurement (Key Performance Indicator Analysis, Balance Scorecard, Ratio Analysis, etc.) – Helps to identify strong & weak areas of the business. Can be used to identify and improve underperforming areas. Gives you a snapshot of the business activities.
  • Capital Expenditure Appraisal – Helps to make capital investments that generate the highest return. A great decision making tool.
  • Working Capital Analysis & Management – Helps to manage short term cash & liquidity more efficiently and effectively.
  • Activity Based Costing – Helps to allocate direct & indirect cost more accurately.
  • Customer Profitability Analysis – Helps to identify most profitable customers. The company can focus on retaining those customers by providing quality & friendly service.
  • Product Profitability Analysis – Helps to identify the most profitable products & services. Can be used to identify the ideal product/service mix.
  • What If / Scenario Analysis – Helps to make more informed decisions by incorporating various factors.

I will try my best to explain most of these techniques in future articles in an easy to understand way for the benefit of small & medium business owners. These techniques will help to understand your business thoroughly and to grow your business sustainably.

First thing first

Before implementing any of these management accounting techniques, it is paramount important to get your chart of accounts right. The chart of accounts of the business is the foundation for better financial & management reporting. All the businesses are not the same. Businesses differ based on their products/services offering, size of the business, geographic location of the business, their business model etc. Therefore, it is very important to get the chart of accounts right in the first place.

In this article I decided to give more emphasis on how to create the chart of accounts effectively, which will ultimately help to implement management accounting techniques more effectively.

All the transactions of a company can be categorized as income, cost of sales, expenses, assets, liabilities or equity. These are the main categories of a chart of accounts where all the business transactions are recorded. From these accounts we can create profit & loss account, balance sheet and the cash flow statement for the business. Therefore, it is very important to record transactions to the correct category in order to measure the actual performance of the business.

It is really important to create sub-accounts specific to the business under the above main categories. For example, a T-Shirt printing company can have sub-income accounts for each printing option, such as screen printing, embroidery, vinyl printing, etc. (see the figure 1.1 below). This way the business owner/manager can measure the income & profits generated by each printing category more accurately & quickly. You can even break those sub-categories into more sub-categories such as In-house printing & outsourced printing.

chart-of-accounts2

Figure 1.1

The chart of accounts should be well structured and be able to answer the following questions quickly and accurately.

  • What is the revenue for each product/service?
  • What is the cost to make & sell each product?
  • What is the gross profit for each product/service?
  • What are the most profitable products services of the business?
  • What are the least profitable products or services of the business?
  • The profits generated from in-house operations and outsourced operations
  • How much are the staff costs for each department or business unit?

If you have setup the chart of accounts properly with appropriate sub accounts, it only takes a few clicks to answer the above questions.

You can ask your bookkeeper or the accountant to review your company’s chart of accounts to see whether they are setup accurately and relevant to your business and the industry.

As mentioned before I will explain some of the important management accounting tools & techniques in an easy to understand way in future articles.

Thank you for reading & sharing.

 

ABOUT THE AUTHOR

Waruna Abeysinghe CPA, CIMA is a chartered Management Accountant and has vast experience in working with small & medium businesses. If you have any questions and feedback you can contact Waruna on waruna.abeysinghe@gmail.com

Harvey Norman Financial Analysis

Harvey Norman Holdings Ltd (HVN.ASX) is one of the largest retailers in Australia which operates under a franchise system. The primary objective of this report is to analyse the publicly available past financial statements to gain an understanding on the performance of Harvey Norman.

Harvey Norman managed to record a healthy sales growth since 2013. One of the reason was the aggressive pricing policy as demonstrated by the GP Mark-up Index (Sales/Cost of Goods Sold). At the same time the company managed to keep the operational & admin expenses at a consistent level. However, it can be noticed that the sales growth of owned stores has decreased in 2015, which is not consistent with the franchise revenue growth.

The sales per owned store growth is look like a roller coaster – up & down year by year. However, franchise revenue per franchised complex growth has seen a consistent growth since 2012. One of the reasons for this growth is the decrease in the no of franchised complexes from 212 in the year 2012 to 194 in the year 2015.

The net profit margin has been increasing in the last couple of years. In the meantime, Depreciation per Revenue ratio declined from 6.8% in 2013 to 4.8% in 2015 even though the gross property, plant & equipment grew at a decreasing rate.

Harvey Norman has managed to maintain their working capital level consistent over the last 5 years. In fact, Harvey Norman managed to bring down the working capital cycle from 147 days in 2013 to 100 days in 2015.

Earnings before interest, tax, depreciation & amortisation (EBITDA) fell considerably from 2011 to 2014. However, we can see an increase in EBITDA in the year 2015. The net cash flow from operations has also increased from 2012.

Overall Harvey Norman performed well under uncertain economic environments and it continues to grow its sales as evident from the 2016 half yearly results.

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NOTE: All the data extracted from Annual Reports available on Harvey Norman’s corporate website.

ABOUT THE AUTHOR

Waruna Abeysinghe CPA, ACMA is a chartered qualified Management Accountant with experience in providing management accounting solutions to small & medium businesses. Waruna is also an experience financial analyst and has worked in various industries from banking, government, education, retail to constructions.