Good timing is the secret to many things in life and in finance, timing is equally as important.
If you run a business that sells products or provides services, chances are that you probably have some stock and work in progress (WIP) within it. Stock is the inventory of finished goods that you have ready to sell, while WIP is the value of the work that you have started but not completed yet. Both of these assets affect your cash flow and profitability, but they also need to be adjusted when you prepare your management accounts.
Management Accounts vs Statutory Accounts
Management accounts are the financial reports that you use to monitor and control your business performance. They are different from statutory accounts, which are the official accounts that you submit to the tax authorities and other stakeholders. Statutory accounts follow strict accounting rules and principles, while management accounts are more flexible and tailored to your specific needs and goals.
One of the main benefits of management accounts is that they can give you a more accurate picture of your income and expenses, as well as your assets and liabilities.
To do this, you need to make some adjustments to your accounting records for timing differences, such as stock and WIP. These adjustments are called accruals and prepayments, and they are based on the matching principle.
What is the matching principle?
The matching principle is a basic accounting concept that states that you should record your revenues and expenses in the same period as they occur, regardless of when you receive or pay cash. This way, you can measure your true profitability and avoid distortions caused by timing differences.
So, the aim is to ensure that sales invoices raised in one month are matched to the costs that relate to them, even if the actual invoice for these costs is not received until later months. Costs that should be recorded but are not yet invoiced will need to be accrued for. When you receive or pay for items becomes irrelevant it’s all about matching costs to value.
How do stock and WIP affect your management accounts?
For instance, suppose you buy some raw materials in December, but you don’t use them until January. According to the matching principle, you should record the increase in stock in December, not January.
Similarly, suppose you start working on a project for a client in December, but you don’t finish it until January. According to the matching principle, you should record an increase in WIP to reflect the fact that costs incurred in December are not relating to sales in December.
Both of these examples increase the asset in the balance sheet and reduce the costs in the P&L and are reversed in the month the sales incurred.
Failure to do this will lead to inaccurate profit figures.
Why are stock and WIP important for your management accounts?
Stock and WIP help you improve your financial reporting and decision making in the following ways:
- Get a more accurate picture of your income and expenses, as well as your assets and liabilities.
- Avoid overstating or understating your profits or losses, and your cash flow.
- Track your inventory levels and turnover, and optimise your stock management.
- Monitor your work progress and efficiency, and improve your project management.
- Analyse your margins and profitability, and identify areas for improvement.
In conclusion, stock and WIP are important adjustments that you need to make when you prepare your management accounts. They can help you follow the matching principle and get a more realistic and reliable view of your business performance.
How we can help.
We can help by making sure that your management accounts are adjusted for Stock and WIP each month or quarter, as well as helping you put systems in place to capture stock and wip adjustment. At the end of the day, you should be making decisions based on good financial information and if your management accounts are not accurate, then this becomes impossible.
