Phil Wright – Manufacturing Sector Specialist
For many businesses, financial reporting is a formality and key decision makers do not tend to challenge the numbers in order to decipher what they really mean.
Financial directors of Small and Medium enterprises (SMEs) often say that financial reports prepared for board meetings are viewed with little interest. Sometimes, this is because the data is not being properly analysed or interpreted accurately, on other occasions it lacks the layer of detail needed to make it meaningful.
Concise reporting is key
As smaller businesses grow, business leaders may find the financials presented by internal finance teams are no longer as relevant as before. For example, it may be too backwards looking or focussed on areas which are not as significant to the business as before. In other cases, the data reported may have been adapted over time but this has caused management reporting to become too convoluted and difficult to navigate.
If a financial report has grown to over 25 pages then it is likely that a business leader will skim read at best, or ignore the whole report at worst! If the reporting pack has got to this size it would significantly benefit from a review. In general reports tend to get better feedback if they are concise, relevant and forward looking. How will these financials impact us going forward? Can we use any of this information to spark positive change?
As business advisers, our teams are often asked by clients for advice on how to make financial reports more user friendly and relevant. We recommend that a management pack is prepared and circulated prior to board meetings so business leaders can pick out key pieces of information to discuss. This helps to make sure there is the right amount of analysis to ensure the data is understood. All management packs should be accompanied by a one page summary of key data in an easy-to-digest format.
As part of its monthly reporting, the business should establish Key Performance Indicators (KPIs) and keep them under review as the business grows. Cash flow forecasts and sales data should be provided to present a realistic view of the direction of the business. The management pack should show comparisons between actual results and pre-agreed KPIs to determine discussion. How might this affect the forecast for next month, the rest of the year and the next year?
Keeping up-to-date data is also important. Board directors want the most recent financial data and are likely to lose interest if the only numbers they are shown relate to the previous month’s performance (potentially 4 weeks after the event!). If this is a recurring issue, financial teams should try to find out why the information is late, it could be as simple as the business waiting until 21st of the month for supplier invoices to be received and entered into the accounting system, then the financial reports will inevitably be delayed. By introducing a rule that all supplier invoices must be received by, say, the 7th of the month to be paid by the end of the month, this could make a significant difference and improve the internal reporting timetable. Do you really need to wait that long? It’s likely your suppliers will adhere to revised administrative procedures to ensure prompt payment, this will mean you can produce more timely information.
Improving financial reports on projects
Reporting financial data in businesses that operate on a project or ‘order’ basis can be more complex, such as those in the manufacturing industry. Some contracts or orders may last just a few months, others a year or longer and so it is important to account for them on a case by case basis. The company needs to clearly know they have captured all applicable costs when pricing its offering. We find having a fresh pair of eyes cast over any costing and subsequent pricing mechanism can be very insightful!
As well as keeping track of payments made and invoices issued, key to each individual piece of work is whether it is profitable or not to the business. To calculate this accurately, the finance team will need to work closely with the operations team to ensure they know what stage of completion the order has reached and whether it is likely to complete on time and within budget and if not, they should include a provision for this. Not accounting for the order correctly, if billed at stage payments, could hide a profitability issue until works are completed, equally, insufficient revenue may be recognised, depending on the completion stage.
Depending on the number of orders underway at any time, it may be important for the financial team to understand the point at which each order is expected to turn cash positive – taking into consideration raw materials, work in progress, labour absorption and finished goods – all of which are likely to be settled before being paid by the customer . This could help to reassure decision makers that cash position is due to ‘timing’, and so the order could still be profitable despite initial cash flow strains, some short-term choppy water to be navigated.
At the outset forecasting the cash flow impact of the order is crucial, this may provide an early warning that short term funding is required, or at least some strong working capital management.
On the other hand, a profitable contract may still put a significant cash flow strain on a business if there is expenditure incurred at the beginning of the project, before any income is received from the customer. If this occurs on a number of contracts at the same time, clearly the impact of this would be compounded.
Forward looking reporting
To ensure financial data is relevant and forward looking, the finance team should introduce forecast modelling to provide a view of how strategic decisions could impact the business’ performance over time. For example, the board may wish to know what would happen if the business was to increase or decrease prices by 1%, or if it recruits a new senior manager to head up an expanding sales function or venture into new territories – what might this expenditure be and what is the ‘payback’ period?.
Demonstrating the cash impact of changes or presenting a range of scenarios should keep the management team engaged. Using forecasting, tracking the accuracy and having a strong suite of timely financial and non-financial reports should give the board the tools to make informed and prompt business-critical decisions.