Account for your profit
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"OFTEN WHEN I have looked at a set of accounts I have told the client that he would be better off to sell his business, buy a bungalow, invest the rest of his money and then stay in bed all day!" How relevant that could be to many road transport operators who have not taken the trouble to find out the true profitability of their businesses. In fact it is an extract from a booklet—it is entitled Account For Your Profit—circulated throughout the retail motor trade by the Economic Development Committee for Motor Vehicle Distribution and Repair. It has been prepared by Mr. Ronald Sewell, a management consultant, and commissioned by the Motor Agents Association.
Although the booklet is directly intended for the retail motor trade Mr. Sewell had much to say which could be of real value to road transport operators, which is why I am reviewing it here.
Many small units Like the road transport industry, the retail motor trade contains a large number of small units. This fact is recognized in the introduction when it is stated that it is essential that executives of every business should be able to understand and use management accounts if they are to control their businesses effectively. This does not mean that they have to become accountants. It does mean that they must be able to make use of the information submitted to them by accountants.
Therefore, it is claimed, the aim of the first two sections of this booklet is to help executives to understand the way in which they can use management accounts to improve the profitability of their business. But management accounts will not be accurate unless they are based on sound accountancy records within the garage. Therefore, the third section is devoted to an explanation of some of the simple but effective systems of internal records and accounting controls which should be applied in any garage.
The last two sections deal with the way in which management accounts should be produced. Here, it is contended, it is likely that the type of management accounts discussed in section 4 will be applicable to garages employing less than 12 people. With a certain amount of amendments to include more information upon the direct costs of each activity they could be amended to become suitable for a garage employing, say, up to 20 people. Above this size section 5 becomes applicable. The performance figures quoted in the section are those which are found upon the basis of wide consulting experience to be achievable by the average garage.
Simple explanation
To the benefit of many transport operators who might seek guidance from this booklet, Mr. Sewell states that it has been written for garage executives with little or no experience of professional accountancy and so he has used every effort to make the explanation of accounting principle as simple as possible. This applies particularly to the section where accounts are explained by way of a "plumbing diagram".
This 90-page booklet is based on talks given by Mr. Sewell at a series of conferences organized by MAA and is obtainable free from the National Economic Development Office, Mil!bank Tower, 21/41 Milibank, London SW
"The tanks in the attic" In Chapter I, Mr. Sewell explains in simple terms various aspects of accountancy by means of his plumbing diagram. Referring to "The tanks in the attic" in the plumbing sense he says that in a business there is a corresponding need for two or three "supply tanks". Dealing with capital, he states that to start a business one must have money of one's own and this is the main supply source for the money the business needs. But as credit terms can be obtained from businesses from whom supplies are purchased this provides a second "tank" from which to finance one's own business. A third source of money is in the shape of bank overdrafts and various forms of loans from outside parties. When starting up in business one may not need any of these outside sources of money but when taking advantage of such money it provides the third supply "tank".
To start a garage one must spend money on building and equipment. Here, Mr. Sewell discloses that in his experience many garages spend too much money on these items. This can have a very serious effect on the profitability or even the survival of the business.
Regarding overhead expenses on such items as rates, light, heat, telephones, stationery, bank charges and professional fees, Mr. Sewell explains that the amount of money spent on the overhead is affected by the amount of money spent on buildings and equipment and by the amount of money borrowed.
Building and equipment spending
Elaborating on overspending on building and equipment Mr. Sewell explains that one might then have to take out a mortgage and so incur additional interest charges. Secondly, for the same reason there would be heavier expenses in respect of rates, light, heat and general property maintenance. In addition the amount by which the equipment declines in value, each year will constitute a further increase. It is clear, therefore, that the amount spent on building and equipment should be kept to an effective minimum.
In any business one cannot get far without employing people to whom one has to pay not only wages but national insurance, graduated pensions and selective employment tax (where this applies). In many small businesses, Mr. Sewell adds, the owner makes the mistake of not charging any wages for himself. To get an accurate picture of his business the owner must include a fair wage for the time he devotes to managing the business himself.
Although written for the motor retail trade, how true these last comments are of many small road transport concerns, particularly when the owner /driver is virtually a maid-of-all-work, manager, driver, foreman-fitter and traffic canvasser all rolled into one. And, worse still, if the practices continue long enough, below-normal rates are established on the basis of unrealistic costs which are hard to raise to more realistic levels when the shortcoming is finally revealed.
Once people are employed, other direct expenses are incurred. In a case of a workshop it will include drills, small tools, cleaning rags, the running cost of breakdowns with public vehicles and so on.
Financing growth—two methods After commenting on stocks and debtors among other items Mr. Sewell deals with two ways of financing the growth of a business, The first is to take longer in paying creditors so that one is making greater use of their money. The second is to increase the amount of outside money you are using. The best method of expansion is to increase the size of your own capital by reinvesting the profits you have earned. In fact, Mr. Sewell adds, the most important function of profits is to ensure the survival and growth of a business.
In a section on the use of practical yardsticks, Mr. Sewell inOsts that a businessman cannot exercise effective control over his business unless he can measure its progress in a practical way against yardsticks which he can understand. The two most important are the rate of interest, that is the "return", being earned on the money used in the business and the number of times the money in the business is circulated. Too many businessmen. Mr. Sewell insists, measure their net profits against their sales though this measurement is of little value. The important yardstick is to measure the profit against the amount of money which the owner has invested in his business. Thus, if the total sales amounted to £100,000, the capital amounts to £10,000 and the net profit is £2,000, then it is more important to know that the net profit is equivalent to a return of 20 per cent interest rate on the owner's capital than it is to know that the net profit is 2 per cent of the total sales.
'Why bother ?'
Apparently a similar malaise to that only too often found in road transport must also apply in the motor retail trade. In Chapter 4, significantly entitled "Why Bother?" Mr. Sewell says that some executives, although interested in the descriptions given in Section 1, might be tempted to ask why they should bother to understand accounts. As long as a local accountant eventually produces a set of accounts for the income tax inspector why should the owner of a garage worry about accounts. All office work, they may argue, apart from being a nuisance, is completely non-productive, so as little time as possible should be devoted to it.
In reply, Mr. Sewell relates a true story and once again I must add how often a parallel example could be found in road transport.
Two friends started a small workshop. They were good mechanics and soon attracted customers. This meant that they worked long hours—weekends as well—starting early in the morning and finishing late at night. Both were too busy in the workshop to worry unduly about the office records. Their wives coped with these as best they could though they knew nothing about office work.
Eventually a local accountant was given the task of sorting out such records as were kept into a set of annual accounts. They felt reassured when they were told they would only have a small amount of income tax to pay. In fact, although a net profit per week of £20 was revealed, Mr. Sewell insists that it would be more helpful to work out the profit on the parts being used and then to express all the other figures on an hourly basis to take account of the full number of hours they were working each week. On this basis the net profit was 2s 5d per man hour.
Because the partners lacked the experience and confidence to find out what their accounts really meant to them, they failed to realize that they were working for this grossly inadequate figure of 2s 5d an hour each.
Essential tool of management There is a tendency, Mr. Sewell adds, to feel that hard work must eventually bring its "just rewards". Hard work by itself will be unavailing unless it is based on accurate information allied to sound planning. Therefore, accounts are an essential tool of management. However, it is not enough to look at what the accounts can mean, you must assess also what the result should have been.
In a later chapter, Mr. Sewell elaborates on the essential job of setting targets. Here he claims that the most important and most essential job of any executive is to work out what profit he must earn and how he can achieve this target figure. Too many businesses are run by harrassed executives who are so busy solving minor, day-to-day problems, that they do not leave themselves time for the main job of planning the future of the company.