How to Interpret and Use Your Management Accounts to Help You

What are management accounts?

Management accounts are a mini set of accounts that include a profit and loss account and a balance sheet. Sometimes they include a cash flow statement and extra pages for job profitability. They are usually prepared monthly or quarterly.

They are not just reports for your accountant. They are prepared to help you as the business owner understand what is happening in your business so you can  spot problems early and and make better decisions going forward.

Why management accounts matter more than year end accounts

Year end accounts tell the story of what happened in the past year. By then, if there was an issue with pricing or old outstanding sales invoices, 12 months may have passed and the issue may have been spotted too late.

Management accounts tell the story of what happened in the last 1-3 months. If there is a problem, it can be spotted much earlier.

Who are management accounts for?

Management accounts are great for growing businesses or businesses with various different jobs on the go, where the owner needs to keep a close eye on profit levels.

This is one of the reasons we offer management accounts for construction businesses as part of our ongoing support.

They can also be useful for smaller, steady businesses, if you, as a business owner, want to stay familiar with your business’ numbers on an ongoing basis. It also gives you peace of mind that your business is going in the right direction throughout the year.

You may want to know what your VAT and corporation tax bills will be each month or quarter, months before they are due. This helps you put the right amount of cash aside each month so the liabilities can be paid when they fall due.

For construction businesses, VAT can be more complicated where the VAT reverse charge applies.

The Profit and Loss Account

When reviewing your profit and loss account, you should compare the figures to the previous month or quarter and consider whether the movement makes sense. If income, costs or profit have increased or decreased, there should usually be a logical reason.

If there is no obvious reason, ask your accountant to explain it. A good accountant will explain any major variations when presenting your management accounts, before you have to ask.

Start with revenue at the top. Seasonal patterns in your business may cause variations from one month or quarter to the next. It is also worth looking deeper into what makes up your revenue, including which jobs produced strong income but poor margins.

Gross profit shows how good your margins are. The gross profit percentage should be reviewed against previous management accounts so you can see whether margins are improving or getting worse.

A movement in gross profit may be caused by changes in material costs, subcontractor costs, or your own pricing. If margins are falling, your management accounts should help you decide whether you need to increase prices, agree better deals with suppliers, reduce waste, or review how certain jobs are being priced.

Overheads should also be reviewed each month. Fixed costs can creep up over time, for example subscriptions, insurance, software, rent, vehicle leases and finance costs.

Overheads can also be misallocated because there are lots of different codes. Any significant variances should be checked with your accountant to make sure everything has been allocated correctly.

Net profit shows whether your business is actually making money after all costs have been included. It should be compared to what you expected, and any higher or lower figures should be explained.

For limited companies, profit also helps you understand what level of dividends may be affordable. Dividends should not be based only on the bank balance, because the business may have tax bills, supplier payments, loans, retentions or other liabilities still to pay.

The Balance Sheet

The balance sheet is a snapshot of your business at a certain point in time. It shows what the business owns, what it owes, and what is left. I’ll seperate each part of the balance sheet into different section to make it easier to understand.

Debtors

Debtors are monies owed to your business. Trade debtors, which are amounts owed from sales invoices, are usually the main balance to review. Ideally, there should be a separate aged debtors report showing who owes money and how old each debt is.

These balances should be reviewed every month and chased regularly. Your management accounts should help you see whether customers are paying within your agreed payment terms, and whether any balances are becoming overdue.

For construction businesses, retentions should also be reviewed. Retentions can tie up cash for long periods, so it is important to keep track of what has been withheld, when it is due to be released, and whether it has actually been invoiced or collected.

Creditors

Creditors are amounts your business owes to other people. This may include suppliers, HMRC, subcontractors, bank loans and director loans.

Similar to trade debtors, trade creditors should be reviewed for old outstanding balances. These should either be paid or written off if they are no longer payable.

Management accounts should also include a running provision for corporation tax and VAT, so you can set aside separate cash pots to pay these when they fall due.

The director’s loan account should also be reviewed regularly. This shows amounts owed to or from the director. If the director is taking money from the business, the management accounts should help identify whether those payments are salary, dividends, expenses, loan repayments or drawings from the director’s loan account.

For limited companies, dividends should only be paid where there are sufficient distributable profits. This is why it is important to review profit, retained earnings and the director’s loan account before taking money out of the company.

Stock and Work in Progress (WIP)

Stock is the value of unused materials at the period end. Your accountant should be asking you for this figure. It’s important you give them an accurate figure because it impacts your gross profit and gross profit margin. Getting it wrong will inflate or deflate your profit, meaning you won’t know your true margins.

WIP is equally important as it affects margins too. It is the value of completed work that has not yet been invoiced.

It can be complex to calculate, but a good accountant will use the ‘stage of completion’ method to calculate it. If you have various jobs in progress, this should be presented with the management accounts for you to review.

Bank Balances

The bank balance is self explanatory, but it should not be reviewed in isolation.

You should also consider what money will be coming in and going out over the next month. This helps you understand whether there is enough cash in the business to cover upcoming liabilities.

If there are cash flow issues, the management accounts should help you decide whether personal cash needs to be introduced into the business, whether debts need to be chased more aggressively, or whether costs need to be reduced.

If there is surplus cash in the bank losing value from inflation, you may want to consider how that cash could be used more effectively. This could include high interest savings accounts, property, stocks and shares, or company pension contributions to reduce corporation tax.

Other Considerations

The balance sheet total should also be reviewed. This is the total assets less total liabilities, usually shown at the bottom of the balance sheet.

If this figure is negative, it means the business owes more than it owns. Your management accounts should help you understand why this has happened and what needs to change to move the business into a stronger position.

If you are looking at taking on new staff, management accounts can help you model the impact on profit. You can estimate the additional wage cost, compare it to expected extra sales, and decide whether the new staff member is likely to improve or reduce overall profit.

Final Thoughts

Management accounts can be a great asset to your business, but only if they are explained and presented to you in the correct way.

The value is not in the reports themselves, but in using them to make better decisions.

Any good construction accountant should be doing this for you. If you want to know other key differences between a construction accountant and a generalist accountant, I’ve explained this further in my article what a construction accountant does (and how it saves you money).

If you run a construction business and want clearer numbers throughout the year, you can learn more about how we help here accountants for construction businesses.