Time and time again I see the same issue with the way accounting systems have been set up. The reports do not separate different income streams in a way that management can use the information to improve profit and understand exactly what is happening within their business.
Take Bob and John for example. They own a website business that not only creates websites for clients but does SEO work and graphic designs for banners and other online graphic design work. There are effectively three different income streams in the business and for years Bob and John would talk about which income stream they felt was bringing in the big revenue and which income streams were not doing so well. They differed in their view and would argue about the business direction because they didn’t have the correct information to make the decision and they just couldn’t agree with their differing views.
Following advice to do so, they made changes to the way their accounting system was structured and how the bookkeeping data entry was processed so that they could obtain profit and loss statements for each of the divisions every month. After a couple of months, it became crystal clear that one of the divisions was making very good profits, one was losing money and the other was making an ok profit.
There were three key lessons that not only Bob and John learnt, but are relevant to every business:
It’s never too late to change the way your accounting records are set up. Once Bob and John had the information, they regretted not knowing that they had this option earlier and implementing the change much sooner in their business.
Most accounting systems have this capability built into them. Although the names are different, it could be jobs, tracking categories, projects, divisions, the functionality is similar and the ability to report profit and loss by income stream is possible.
Bob had always believed that the income stream that was actually losing money was their top earner and he had put a lot of effort into building up that area of the business. Although gut feel is important in business, having accurate financial data is equally important as either a sanity check or in this instance to provide information that was opposite to expectation. Armed with this information, Bob now understands why his efforts to build the business which had appeared to be in vain, were actually causing the business to be less profitable.
Susan, on the other hand, has a broking business and is developing a new product to educate the market about her business. Susan has a well-established business that had been making profits each month of a figure that she expected. However, in the past few months, the profits seemed to have disappeared as her profit and loss statement was showing that she was at break even. A closer look at the numbers revealed that she was undertaking some significant research and development work on the new product and the costs had eroded her profit.
After a review of the last months’ results, Susan was feeling quite disappointed with the results, and yet the business had made the same profit as she had been making and what she had expected to make. Susan sought accounting advice and has now moved the ongoing research and development activity to a separate entity leaving the existing entity with the business trading. In this way, she will be able to see that the business is trading the way she expects it to and will be able to monitor the financial commitment she is making to the new project.
There are two more lessons we can all take from Susan’s situation.
When undertaking different types of work, it is sometimes worth considering splitting the business into different entities, but only after seeking accounting advice on the matter.
By splitting out a specific income stream that may be costing money in the short term from the existing business makes it easier to see the costs associated with establishing that income stream. It is in the visibility of these numbers that allows for conscious decision-making about those costs rather than them being included in the general costs of the business.