How to make better sense of your annual accounts

Accounting was invented more than 500 years ago by the Italian monk Pacioli.
The problem is that it hasn’t really improved much since then, and as a result
most accounts produced for businesses aren’t all that useful.

The worst offenders are the end of year accounts produced by accountants for
sending to the taxman and Companies House. As a recent report from the ICAEW’s
faculty of finance and management puts it: ‘Every aircraft in the world today
would be grounded if air traffic control relied on the same type of system as
companies use today to report their information. Current reporting formats
provide too little, too late.’

According to a survey of more than 250 accountancy firms, 73% of partners
(that is, the people who make their living producing annual accounts)
acknowledge there are at least five fundamental flaws in annual accounts. Of
course, 73% of accountants are not saying that accounts are wrong, don’t add up
or don’t fully comply with all the relevant laws and reporting standards. What
they are saying is that annual accounts are of little or no use to the
businesses that are forced to pay for them since they don’t give business owners
the information they really need to drive their businesses forward.

Some accountants believe this is not their problem. After all, they argue,
they are producing fully compliant accounts, so why should they do more? The
answer is simple: because to stop there is to let clients down. Businesses need
more – and, indeed, deserve more – from their accountants.

Hundreds of accountants are already rising to this challenge by adding a
‘confidential performance report’ to the accounts they produce. This new kind of
report, sets out, in plain English, how the business compares with others in its
industry, its key financial strengths and weaknesses, how much additional profit
the evidence suggests the business is missing out on, and how the business can
reclaim those missing profits.

Produced in minutes using the new breed of benchmarking software readily
available to practices, these reports are prepared and presented with the annual
accounts – but are for the management’s eyes only, and are not sent to HMRC or
Companies House. Not only do they deliver new insights and real value to
clients, they also differentiate the accountants producing them. As a result
they make it much easier for the firms writing them to win new clients, keep
existing business and charge premium prices.

But according to more than 200 firms, even that approach is not enough. They
have co-funded the development of a new type

of performance measurement and improvement (PMI) system that picks up where
traditional accounts leave off. And one of the major banks is so impressed that
hundreds of its managers are systematically recommending PMI to their customers.

The PMI approach builds on what accountants have always done, but starts
where traditional accounts finish. Essentially, it is an eight-step codification
of best practice.

Successful businesses recognise that the traditional profit and loss account
and balance sheet do not give them enough information to really drive their
businesses forward.

So most successful businesses also measure other key success drivers (also
known as key performance indicators, or KPIs), so that they can really
understand what is happening while there is still time to do something about it.

The only information that traditional management accounts give about sales is
the value of invoices raised. But for many businesses that kind of
backward-looking ‘lag indicator’ is not that useful for understanding what is
already happening, or predicting what will happen next.

Much more helpful for managing sales are key success drivers such as the
number of sales leads, the conversion rate from lead to sale and the size of
order books. Most successful businesses are now systematically mapping out and
measuring those key success drivers.

In fact, the most successful businesses now systematically identify and
measure KPIs for every key area of their business. And the new PMI systems help
other businesses become more successful by doing this too.

Everything that really matters in a business can be measured by a number. It
may be perfectly obvious what some of those key numbers are, such as the number
of customers, sales figures, profits and tax bills. Some are a little less
obvious, such as how many hours staff have to work a week, and how many weeks’
holiday they can take a year.

And some can be measured only on a more subjective scale, such as customer
satisfaction levels, team morale and employees’ personal happiness.

But everything that matters can be measured by a number. And, here’s the
really important part: I have never met a business that doesn’t want to change
some of those numbers, whether that’s the number of hours its staff put in, the
number of customers they have or the number of pound notes they have in the
bank. Every business wants to change the numbers.

So that is what accountants should be doing: using their skills with numbers
to help clients measure and change (in other words, improve) the numbers that
matter. In fact, to me it is what accountancy actually means – changing the
numbers. Not through creative accounting, of course, but by using our
understanding of what lies behind the numbers to bring about real change.

That is why the eight-step PMI system approach is so valuable. It helps
businesses understand and change the numbers that really matter to them.

Some accountants argue that they help their clients in all these ways
already. But it is not about doing this some of the time for some clients. It is
about doing it all of the time for every client, because they all deserves this
sort of input, guidance and support.

EIGHT STEPS TO BEST PRACTICE:

Step 1: Decide what you want to achieve in the year

Step 2: Measure how well you actually perform each month

Step 3: Measure your full year’s performance

Step 4: Evaluate your performance by comparing with previous
years

Step 5: Evaluate your performance by comparing it with the
rest of your industry

Step 6: Estimate how much your business is worth

Step 7: Calculate how much more profitable and valuable your
business could be

Step 8: Develop a performance improvement plan

FUNDAMENTAL FLAWS IN ANNUAL ACCOUNTS

• They don’t make easy reading

• They don’t show how a business is doing compared with others in its sector

• They don’t identify strengths and weaknesses

• They don’t identify the scope for improvement

• They don’t support decision making

• They don’t show all the numbers that matter

• Too many of the numbers they do include are based on judgement

• Most of the numbers are seriously out of date by the time anyone sees them

Steve Pipe is chairman of the AVN network of accountancy firms