Management accounts: a reasonable demand?

Management accounts: a reasonable demand?

Are credit insurers demands to see management accountants a positive step for the profession or a dangerous precident? David Allen looks at the dangers

The demand from credit insurers that clients’ customers reveal their
management accounts is a bit like Aesop’s classic fable ­ it’s all about the
wolf in sheep’s clothing.

Credit insurers have asked for monthly management accounts so that they can
make a more realistic assessment of their risk of default.

Management accountants’ initial reactions are likely to be positive. After
all, it draws attention to the fact that, in a rapidly changing environment,
published accounts issued up to nine months after the end of the period to which
they relate are of no use whatsoever to the management of the business concerned
­ so how could they possibly be useful to the outsiders looking in? Yes, if they
themselves could see their customers’ management accounts, they would be more
comfortable about the decision to grant credit.

If this new initiative draws attention to the limitations of published
accounts, perhaps it will enable management accounts to come out of the shadows,
and emphasise how much more relevant they are at the level of the individual
business. Before we rush in, however, let us think about some of the downsides.

Firstly, do those outsiders understand the thinking which underlies
management accounts?

All too often, people use that expression when what they are hoping to get
are interim financial accounts, conforming to common standards. The point is
that management accounts are customised to the needs of the particular business
and its management team, in support of its objectives and strategies. They focus
on accountability rather than the nature of expense, they recognise the
variability of costs in a way which the required absorption costing cannot, and
so on.

Secondly, there is the time taken to produce the accounts.

Management accounts are prepared so soon after the end of the month that they
cannot possibly achieve the same degree of objective verifiability as annual
accounts, on such matters as provisions for slow moving stock, doubtful debtors,
etc. It is worth noting that a complete set of accounts every month is not
always needed.

In small/medium businesses with which I have worked, I have often created a
‘financial highlights’ routine each month (sales, contribution, wages and
salaries, cash generation, etc.) and produced a full set of accounts only once a
quarter.

Thirdly is a timing issue of another kind.

Every business is different, and the timing of income and expenditure varies
enormously. It may well be, for example, that because of seasonality, a business
shows a loss for the first few months of the year but more than makes up for it
in the later months.

Would outsiders understand this, or panic (i.e. withdraw cover)? If they were
made aware of the seasonality, would they demand comparisons with the previous
year ­ as though that were a valid benchmark?

This brings me to the fourth point, which is that management accounts
incorporate forward looking information, like budgets (increasingly rolled
rather than rigid), forecasts and standards. Indeed, in a fully developed
system, the main purpose of the accounts is to provide reassurance that the
prevailing forecasts are realistic (or provide a basis for their updating).

One of the best kept secrets of the profession is that accounts do not
provide decision support information ­ that is the role of forecasts and
budgets. So, it should come as no surprise that, when any outsiders get sight of
a set of management accounts, they ask for the more important forecasts. Whether
they would understand the concept of uncertainty, and the consequent tolerances
on forecasts, however, is another matter.

Finally, and in my view the most dangerous aspect of this exercise, is that ­
as is well understood in the physical sciences ­ measurement is an interference
which can have adverse effects. We have seen it in the quoted company arena,
where the accounting model is used way beyond its design specification.

If senior people’s rewards depend on measures like reported profits (or
derivatives like earnings per share) then those measures become the objective.

Readers will be well aware of how reported profits can be improved, e.g. by
skimping on those investments which are treated as costs (research, development,
marketing, training etc).

In short, emphasis on short term measures crowds out long term judgements. It
would be only natural of directors of businesses which were required to submit
management accounts to insurers, in order to be confident of maintaining
continuity of supplies, to think ‘what would the insurers like to see?’ and act
accordingly, to the detriment of the long term health of the business.

The demand for management accounts is a very important development and worthy
of debate.

David Allen CBE is a past president of the Chartered Institute of
Management Accountants, a company director, and an adviser on Strategic
Financial Management

Share

Subscribe to get your daily business insights

Resources & Whitepapers

Why Professional Services Firms Should Ditch Folders and Embrace Metadata
Professional Services

Why Professional Services Firms Should Ditch Folders and Embrace Metadata

3y

Why Professional Services Firms Should Ditch Folde...

In the past decade, the professional services industry has transformed significantly. Digital disruptions, increased competition, and changing market ...

View resource
2 Vital keys to Remaining Competitive for Professional Services Firms

2 Vital keys to Remaining Competitive for Professional Services Firms

3y

2 Vital keys to Remaining Competitive for Professi...

In recent months, professional services firms are facing more pressure than ever to deliver value to clients. Often, clients look at the firms own inf...

View resource
Turn Accounts Payable into a value-engine
Accounting Firms

Turn Accounts Payable into a value-engine

3y

Turn Accounts Payable into a value-engine

In a world of instant results and automated workloads, the potential for AP to drive insights and transform results is enormous. But, if you’re still ...

View resource
Digital Links: A guide to MTD in 2021
Making Tax Digital

Digital Links: A guide to MTD in 2021

3y

Digital Links: A guide to MTD in 2021

The first phase of Making Tax Digital (MTD) saw the requirement for the digital submission of the VAT Return using compliant software. That’s now behi...

View resource