What is financial management? What your accounts don’t tell you
Would you drive without mirrors, without headlights and with a big smudge in the middle of the windscreen? I hope the answer is no. Running a business without financial management is much the same thing.
I met the founder of an architecture firm who had just received his accounts. The financial year had closed three months earlier, and profit was decent but unremarkable given his revenue. I asked him which of his teams made the most money. Silence. He had all the figures, and no answers to the questions that matter when you have to decide.
Your turn
Your turn: answer in ten seconds
- What is your gross margin, in euros and as a percentage of revenue?
- Which business unit, partner or activity produced your profit last year?
- How many months of costs does your cash cover today?
When I say “financial management”, many business owners hear “accounting” and file the subject under obligations. It’s a costly misunderstanding. Accounting is a legal obligation, and it is the first foundation of a company’s financial structure. But it produces one overall result, once a year, in a format designed for tax. It tells you how much the company earned. It doesn’t tell you who earned it, on what, when, or what would have needed to change to earn more. And it tells you about a year that is already over, when the die is cast. It sheds no light on your present, nor on where you’re heading.
Financial management does the opposite. It starts from the same figures but projects them forward, to inform the decisions you have to make in the coming months: a hire, a pay rise, an activity to keep or to stop. It is the missing link between figures that are accurate but silent, and figures that answer questions. It is built in four steps.
Step one: reconcile your different sources
In every company I meet, there is an accounting record and a sales record, and often a payroll kept separately. The information is supposed to be the same. It never quite is, and blind spots live in those gaps.
So I always start by reconciling the sales file with the accounts, job by job. Several hundred jobs over a financial year, each one traced through the invoices, until the total balances to the cent. The work looks thankless. It is what guarantees a sound basis for analysis, and it is what brings to light what nobody could see: services paid for but never recorded, expected costs still missing, and overtime scattered across payslips which, once added up, amounted to nearly a full year of full-time work paid on top of salaries.
Financial management starts with reconciliation. As long as sales, payroll and accounting tell three different stories, no information can be trusted.
Step two: rebuild the P&L in your own language
The second step is to rebuild the profit and loss account in the business owner’s language rather than the tax authority’s. Statutory accounts aren’t designed to speak to you. A decision-making tool must give clear, concise information suited to the business it serves.
The management P&L answers a single question: where does profit come from, and what makes it move? It takes the figures from the accounts and reorganises them for you, by business unit, by activity and by month, in five blocks that never change.
Revenue
Revenue, read according to a convention chosen deliberately and written down: at signature, at invoicing or at delivery, the three readings of the same year are different.
Gross margin
Gross margin: what remains once the costs directly linked to your services are deducted, and the denominator of everything else.
Payroll at full cost
Payroll at full employer cost, social charges included, not gross salaries: the gap between the two is commonly a third of what your teams cost.
Overheads
Overheads, grouped into a few stable categories, which in most service SMEs are not the issue.
Operating profit
And finally operating profit, which only means something relative to the rest.
This P&L serves three purposes. To compare, because a figure on its own says nothing, while a payroll-to-gross-margin ratio by team, over two financial years, says everything. To anticipate, because once the model is in place you can test an assumption, a hire, a pay rise, a lost client, and see what happens to profit before you decide. And to settle questions, because it replaces impressions with a figure everyone in the company reads the same way. It isn’t meant to be accurate to the cent in the tax sense; it is meant to be right, reconciled with the accounts, and readable in ten minutes by someone who isn’t a finance person.
Step three: go down to the level where decisions are made
An overall P&L, however clean, is still an average, and an average hides everything. The third step is to break it down to the level where decisions are actually made: by business unit, by partner, by activity. With one non-negotiable requirement: the units must add up exactly to the company total, and the total must reconcile with the accounts. Every remaining gap is a documented choice, never an unknown.
Simulator
What happens to my business unit if I add an assistant?
Indicative orders of magnitude, excluding overheads, to be checked against your actual accounts.
It is at this level that the important discoveries happen. At our architect’s firm, the unit with the highest revenue, the most profitable in the firm a year earlier, had become the least profitable. Not because it was winning less work. Because on the back of a good year, its head had been given an extra assistant and pay rises, granted in good faith, on the strength of profitability that was a year old. The support built around him now cost more than the extra it brought in. No bank statement, no tax return shows that. A P&L by business unit does.
Step four: keep it regular
Once the tools are built, financial management has to become part of your SME’s life, otherwise it produces out-of-date information. The checks are rerun and the forecasts updated every month. Provisions are compared with actual entries at every close, because a provision that is right in April can become double counting by July. And above all, the figures lead to decision thresholds, set together with you.
To come back to our founder from the beginning: today he runs his firm on clear indicators, which we defined together based on what he wanted to achieve. He no longer decides on gut feeling but on figures, and every hire or investment is decided calmly. The figures are produced; the decisions remain his.
So, what is financial management?
It is the discipline that turns accurate accounting into informed decisions, in four steps: reconcile your sources with one another, rebuild a P&L in the business owner’s language, break it down to the level where decisions are made, and keep it alive every month with checks and thresholds.
It isn’t reserved for large groups. It is precisely in companies of ten to fifty people that the need is greatest: big enough that the owner no longer sees everything, too small for a full-time finance director. The accountant produces the accounts and establishes the past; that is their role, and their accounts are the raw material for everything above. Financial management answers the other question, the one that keeps you awake at night, or should: where is the money going, who is earning it, and what do I decide next month?
What you can check tomorrow
Take out your latest annual accounts and your latest bank statement. Answer three questions, without anyone’s help:
One unanswered question, and your accounts are accurate but you are flying blind.