Managerial Accounting

Men and women with a limited understanding of accounting started most businesses. Their bookkeeper compiles information for their accountant but the owner knows that the tax return that their CPA prepares is not a true indication of how their business runs. Their accounting produces nothing that they can really use so they ignore it. They become frustrated because they don’t know what they can afford nor when they can afford it. They compensate by tracking some areas—usually sales and relying upon their “gut feel.” The good news is that the more experienced the business owner is, the more likely that his “gut feel” will be correct. The bad news is that the business easily outgrows this method and it is impossible either to delegate this management style or to transition this style to an heir or successor. Sooner or later the small mistakes become big dollars. The owner becomes overworked and less effective. They can’t get away and they can’t get out. They are trapped. They have been set up for failure.

With my clients I often use this analogy. “Look out of the window. Imagine that you see a young child crossing the street. A speeding car approaches and hits the child—a terrible, terrible tragedy. After you observe this event you sit down and write three letters describing the tragedy. The first letter is to your best friend. The second is to your young child and the last is to your lawyer. Each of the letters is truthful but imagine how each will be different. These letters are the same as your accounting needs.” The only “letter” that the owner currently produces is a letter that the bookkeeper has written to the CPA for the purpose of taxes. This is a very important letter but it does not provide the owner with what he needs to run the business. Most owners recognize this deficiency but simply just don’t know what to do about it. They are getting the wrong letter. Imagine how baffled the young child would be if he received the letter written to the lawyer.

All information produced by a company must meet four criteria: it must be timely, accurate, usable and produced at a minimum cost. Timely means that it must be delivered at a point in that acting upon the information can make a difference. If a football coach covers the scoreboard during the game and then waits until Tuesday to read the paper to find out if he has won or lost, he has not received timely information. As absurd as that sounds, that is exactly how many business owners operate. The term accurate is often misunderstood. In our context accurate means as accurate as is necessary for the purpose of the report. Accountants and bookkeepers put a very high standard upon accuracy that is good—especially for tax purposes, however, all reports do not require that same degree of accuracy. Accountants and software completely overlook the “usable” criteria. Business owners rarely have the same level of sophistication regarding accounting as their CPA and therefore the format of the reports needs to be adjusted. This is particularly true as the reports filter down through the organization. If it is not understood, it is of no value. Lastly the information must be produced at a minimum cost. There is a cost to the production of all information and it is senseless to spend $500 to create a report that generates $100 of profit.

Historical vs Projected

Information provided by your accountant is historical information. Anything that has to be prepared and reviewed in-house, then shipped to the accountant, reviewed and compiled there and then shipped back to the owner has to be historical. Historical information does have its’ place. In looking for trends, identifying where the company has been and in preparing forecasts, historical information can be very useful. However, the value of historical information diminishes in businesses with rapid change. Small businesses can double their sales in a year. They can move into new locations with completely different overhead structures. They can quickly move to different products and customers. In such an environment, historical information becomes just slightly more than an academic pursuit.

The only thing that is really relevant to the business owner is how the company stands in relation to their plan. But most owners don’t even have a plan! Most owners are so sucked into the daily operations (other people’s jobs) that they fail to do their job. Their first job is to plan. This is a constant process. Man plans and God laughs. The plan is not even intended to work, rather it is intended to create benchmarks against which the company’s performance will be measured. The revision of this plan is a constant process, not an annual event. At least monthly, the owner must review his benchmarks and revise the plan. (Obviously from this plan is generated the operational standards for the organization.) The owner projects revenues and cost of sales—by product or department—and establishes overhead.

Every business can be broken into 4-10 key operational variables. These key variables must be projected and tracked weekly. Why weekly? It is the attainment of these results that determines the profit of the company and that is the reason we are in business. The more that one focuses on the result that they wish to achieve, the more likely they are to achieve that result. There are no lasting religions that have people come to church once a year, or once a month, or once a quarter. A weekly focus is exponentially more likely to deliver your result. The timeliness of the information in this instance is more important than the accuracy. You will have a difficult time convincing you bookkeeper of that because their entire orientation is towards accuracy, however the purpose of these “flash reports” is not their accuracy—it is the focus that they create. If a report indicates that a number is out of the range of the owner’s established benchmark, it then is the responsibility of the proper person to identify why and what is being done to correct it.[1] (As scary as it seems to some owners, there are variables that must be tracked daily! But learn to walk before you run.)


[1] It is important to keep your information needs in the proper perspective. The owner must first create a plan—a vision—and identify what it is that they are trying to achieve. An important part of that plan is the financial plan as discussed herein. Once established, the company’s organizational structure becomes the delivery system of those results. Each job requires a defined result and that result is determined by your plan. Organizational Structure is examined in Part II. Finally the information systems monitor those results. Their purpose is to alert the owner as to whether or not he is performing his plan.