How to read your management accounts: a plain-English guide

What management accounts are, and what they are not

Management accounts are the internal report a business reads each month to see how it is going. They are built from the bookkeeping records in Xero, QuickBooks or similar, and they sit between the day-to-day transactions and the year-end statutory accounts lodged with ASIC or the ATO. Statutory accounts look back once a year and follow accounting standards strictly. Management accounts are more flexible: they are updated monthly, they can be arranged by product, team or location, and they are built for decisions rather than for filing.

A monthly management pack usually contains three statements, a short commentary and a few supporting schedules.

The three statements

1. Profit and loss (P&L)

The P&L, sometimes called the income statement, shows revenue earned and costs incurred over the month. It is built on the accrual basis, so revenue appears when the work is done and costs appear when they are incurred — not when cash moves. The main lines are:

• Revenue: sales invoiced in the month, net of GST.
• Cost of goods sold (COGS) or cost of sales: the direct costs of delivering those sales.
• Gross profit: revenue minus COGS. The ratio of gross profit to revenue is the gross margin.
• Operating expenses: rent, salaries, software, marketing and other overheads.
• Operating profit (EBIT): gross profit minus operating expenses.
• Interest and tax: finance costs and the income tax expense.
• Net profit: what is left after everything. Net profit divided by revenue is the net margin.

2. Balance sheet

The balance sheet is a snapshot on the last day of the month of everything the business owns and owes. It is split in three: assets (cash, debtors, inventory, equipment), liabilities (creditors, loans, GST and PAYG withholding owed to the ATO, tax provisions), and equity (paid-up capital plus retained earnings; equity equals assets minus liabilities).

3. Cash statement

Cash is the one line that is not an estimate. The cash statement shows how cash moved during the month: how much came in from customers, how much went out to suppliers, staff, the ATO and lenders, and the closing bank balance. Profit and cash can look very different in a given month because of timing — for example a large invoice raised in September may not be paid until November, so September profit is up but September cash is not.

The numbers worth checking each month

Revenue and gross margin

Look at revenue for the month, year-to-date and compared to the same month last year. Then look at gross margin as a percentage. A dropping gross margin while revenue is steady usually points to rising input costs, discounting, or a shift in sales mix. An illustrative example: a bakery with $120,000 of revenue and $42,000 of ingredients and direct wages has a gross margin of 65 per cent. If next month revenue stays at $120,000 but ingredients and wages rise to $54,000, the gross margin falls to 55 per cent — the P&L has lost $12,000 of profit before any overheads.

Operating expenses and net margin

Operating costs usually sit in a few buckets: people, premises, software and marketing. Running the ratio of each bucket to revenue month over month shows which category is growing faster than sales.

Cash and runway

Cash on hand divided by the average monthly net outflow is the runway. There is more detail in cash-flow forecasting.

Debtor days and creditor days

Debtor days measures how long it takes on average to collect from customers; the usual formula is accounts receivable divided by revenue, multiplied by the number of days in the period. If debtor days drifts up, cash is being lent to customers for longer.

Customer concentration

If one or two customers make up most of the revenue, the business is sensitive to anything that happens to those customers.

The questions to ask each month

1. What changed in revenue and gross margin, and why?
2. Where did operating costs move away from last month and from budget?
3. Did cash move in line with profit? If not, what caused the gap — debtors, stock, tax or capital spending?
4. Which numbers would make it hard to pay suppliers or the ATO on time?
5. What are we going to look at again next month?

Reading the balance sheet alongside the P&L

Profit on the P&L is useful but partial. A business can be profitable and short of cash if debtors are rising and the ATO is owed money. Reading the balance sheet alongside picks that up quickly.

Where Nella fits

Nella is an AI finance assistant for small businesses, built by the accountants at AccTek Ltd. Connected to Xero or QuickBooks, it can produce a monthly management pack from the live books and answer plain-English questions about the numbers. Information only; judgement calls go to a registered tax agent or qualified accountant. There is more on the pack at management accounts and on the margin KPIs at profit and KPIs.

Sources

• business.gov.au u2013 Financial statements
• ATO u2013 Record keeping for business

Nella provides financial information and education, not accounting or tax advice. Nella shows you the numbers. When a question needs professional judgement, such as a filing or a tax decision, Nella says so and points you to a qualified accountant.