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Venturn Most common causes of business failure - Management Accounts.

Most common causes of business failure

As I work mainly with distressed businesses, I'm often asked 'what's the most common problem?'.

In my experience a common factor in nearly all business in distress is a lack of understanding of the financial performance of the business, which is derived from the Management Accounts.  Here are some of my observations on common mistakes that can be easily rectified.

  • 1. Poor Key Performance Indicators (KPIs)
    KPIs often focus on financial issues but operational performance drives the financial results.  Operational KPIs are therefore more important, and also act as early warnings.  Make sure that your KPIs measure all areas that you want to improve i.e. Billable hours, ineffective work, customer complaints, lead-times, stock turns.
  • 2. You produce a balance sheet, but you ignore it
    Unrealisable assets are in effect undisclosed losses.  Ask yourself the question; is all of my stock value truly realisable and will it turn into future profits?  In most cases, the answer this question is 'No' so don't kid yourself.  Excess inventory that remains unchecked can be your biggest cash drain and the biggest write-off figure that you will ever see.  Make sure that you control your inventory.
  • 3. A P&L without a balance sheet is pointless as you are only seeing half of the story.
    An extremely common cause of distress is when you don't account for monthly stock movements.  This shows up as a flat constant number on the balance sheet.  You might therefore be consuming stock, so your cost of sales are higher, your gross margins are lower and your P&L is not showing a true picture.  I find one business per month that is suffering from this problem.
  • 4. You read the management accounts, but don't understand them
    This again is very common. If your senior team don't understand that 'a rising asset is costing you cash', then they should be educated to do so as your operations team have the power to reverse this situation. We all need to focus on translating accounting figures into real world business issues. In my experience, around 2 out of 3 of failing businesses admit that they suffer from a lack of understanding of their management accounts.
  • 5. You produce accounts for your bank, but don't read them yourself
    This again is very common.  If your senior team don't understand that 'a rising asset is costing you cash', then they should be educated to do so as your operations team have the power to reverse this situation.  We all need to focus on translating accounting figures into real world business issues.  In my experience, around 2 out of 3 of failing businesses admit that they suffer from a lack of understanding of their management accounts.
  • 6. You don't produce any management accounts other than year end statutory accounts
    This is like driving a car at night without any lights.  It's only a question of time before you hit something slow and avoidable.  A very common assumption in SME’s is that your accountant is actually checking your accounts on their once a year visit and that they will then providing you with business advice.  The bad news is that he/she is not, they are reviewing your tax position, and if your figures are non-sense, then you yourself stand a much better chance of spotting the errors that they do.  This unfortunately is common to nearly 1 in 4 of SME's that I visit !

Further reading

Stephen Moon, Venturn Ltd. May 2010

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