Do you have a checklist for your month end closing process? Have you added running analytical testing to your checklist?
Managing multiple association accounting systems does not leave a lot of time to thoroughly review everything, which is, of course, why we created our checklist in the first place. I can determine what has been completed and by whom and then spot check their work. It also helps that we have solid systems to fully vet transactions as they are incurred and which work hard to detect and prevent fraud – but still, the goal is to provide full information for the month and year-to-date so we struggle with determining what might be missing.
First, look at some relationships between your balance sheet and your statement of operations. Certain accounts have very comfortable relationships – think inventory and cost of goods sold while others may be more tenuous. Also, keep in mind that the purpose is to help you determine if the statements appear reasonable; so don’t overdo the number of calculations.
Some key ratios you should consider running at month end to help you pinpoint potential problems:
Days in Accounts Receivable
This will give you a sense of potential collection problems without having to dig into the aging: Take your monthly revenue and divide by 30, this is daily sales. Then divide this amount into your accounts receivable balance. Now, the two most important questions you should ask yourself: Is it over 30 days? Is it higher than prior periods? If it is more than 30 days, you have sales from prior months which have still not been collected and if it is increasing, then you have many sales which are not being collected and you might need to consider increasing your allowance for potential bad debt.
Days in Inventory
This will give a good idea if inventory is being handled well without worrying about a potential physical count of inventory. Take your cost of goods sold and divide by 30, which is the daily cost of sales and then divide this amount into inventory. Is the pattern consistent with prior months? Did you see an unexplained change that skewed the results well beyond prior months? A large increase could indicate that some CoGS were not adjusted properly or that potentially you have inventory which is not turning over, potentially indicating obsolescence.
Sales Growth Rate to change in A/R
Comparing the growth in sales to the change in accounts receivable can also provide an indication of deteriorating a/r quality. If your sales increased by 5% from the prior months but your accounts receivable increased by 25%, it could indicate that collection problems might exist.
Gross Profit Percentage Month Over Month
If your company sells products, this could help you address a change in your business or in customer demand – either of which could indicate other potential problems. You will want to map out your gross profit percentage – which is revenues less cost of goods sold and divided by revenues – for each month over the past few years. First, compare it to the past few months, is the trend consistent? Then compare it to the same month in prior years. If you are trending downwards both over time and in comparison to the same period in prior years, this could indicate possible issues with the costs of materials or production issues, both of which can have long-term impacts to your business.
Labor Costs to Revenues
One area where a small business can be caught off-guard is in labor costs. Unplanned overtime can be especially painful so always watch to ensure that overtime is planned and paid for, either in revenue premiums or in additional sales. If labor is consistently increasing during months of slow or no sales growth, perhaps your overtime policy needs to be re-evaluated to ensure that it is not out of control.
In this example, taken from a client who was experiencing reduced profits, we were able to identify the driver was in fact over 1,400 overtime hours. There were two primary drivers of this, first was that department managers did not actively plan work for the week, leaving things to be completed on Wednesday and Thursday so they could be shipped on Friday. Since there was always a lot of work to complete, the teams were working 2-3 extra hours on those two days, even if Monday and Tuesday had the teams with substantial idle time. Second was that there was no policy to require the manage to authorize the use of overtime in advance.
Analytics can help you understand how your business operates. It can point out areas where additional effort might be called for and also help management isolate and test potential issues to see if a change can help improve performance.