Since this series is primarily concerned with the question “What is money?” it’s necessary that we at least have a general historical perspective of humanity’s relationship with money. What money have we used in the past, and how has it changed as humanity came into contact with successively superior forms of money?

We weren’t always using rands and dollars. Money, just like technology, language and life itself, evolves. In fact, the most recent form of money, fiat, will only be 50 years old in 2021. More on this topic in a moment.

The traits of sound money 

Examples of primitive forms of money are numerous: shells, salt, glass beads, cattle, rare stones etc. These early forms of money were by no means perfect and lacked several of the characteristics of sound money as outlined below:

The hardness of money is its resistance to unpredictable supply increases and debasements of value. Fungibility requires that units are interchangeable and indistinguishable from one another. Portability is the ease with which monetary units can be transported and transmitted across distances. Durability entails the resistance of monetary units to rot, corrosion or deterioration of value. Divisibility is the ease at which monetary units can be subdivided or grouped. Security is the resistance to counterfeiting or forgery.

Of the traits listed above, hardness is the most essential. Historically, only truly scarce and hard-to-acquire items could function as a reliable form of money – scarcity was the critical element. This scarcity could be unlocked by expending tremendous amounts of human time and energy. In other words, it was a challenging process to come into the possession of this scarce item. The harder it is to create this money by expending time and energy, the harder the actual money is. That is why humanity eventually settled globally on gold as the superior form of money: it had an annual inflation rate that was closest to zero and satisfied the majority of the critical traits of money. Eventually, even silver was demonetised in most parts of the world as the supply could more easily be inflated by expending more energy. With gold, this was the hardest to do.

Money hacking and the birth of inflation

Terrible human tragedies have occurred in the past where different groups of people came into contact with others using relatively “softer” forms of money. Inevitably, one group’s money could easily be “hacked” by the technologically superior group.

For example, when Portuguese and other European traders came into contact with West Africans exchanging tiny glass beads on the Gold Coast, known as aggry beads, they realised that the West African people had no interest in their foreign money. The Portuguese, however, had access to Venetian glass-making technology which was lightyears ahead of the West Africans at the time. These traders went back to Europe, accumulated many cheap glass beads, and flooded the Gold Coast’s “scarce” money with cheap money. The aggry bead had been hacked. The Portuguese proceeded to trade everything of actual value – food, clothing, cattle, land and so on – for worthless glass beads. It was time and value theft on a monumental scale. The scarcity of West African money was corrupted, and a world of value was confiscated.

There are various other examples of this type of “money hack” occurring throughout history. Another interesting example of this happened on the island of Yap in Micronesia, where the Yapese’s precious Rai Stones could be quickly and cheaply created by an Irish-American captain and his crew who got shipwrecked on the shores of Yap.

–  Rai Stones on the Island of Yap

Today, this same surreptitious form of theft is happening on a global scale that dwarfs these historical scenarios. The mechanism that makes this possible is commonly referred to as inflation, whereby more money is created and injected into the economy, supposedly to stimulate spending and economic growth.

Inflation is taxation without representation – everyone who holds cash pays this tax – but since it’s not a direct payment, nobody notices or realises that their hard-earned value is slowly melting away. Historically, the rate of devaluation has been too gradual for us to feel the diminishing value and purchasing power of our money (much like the proverbial frogs in boiling water). Still, there is reason to believe that this is about to become increasingly evident in the years to come.

What happened in 1971?

The reason that we’ve been able to uninhibitedly create money out of nothing for the past 50 years (as of 2021) is because of the following oft-forgotten moment in history:

In 1971, President Richard Nixon effectively abandoned the global gold standard. You can find the whole speech online, but here’s the crucial snippet for context:

“In recent weeks, the speculators have been waging an all-out war on the American dollar. The strength of a nation’s currency is based on the strength of that nation’s economy — and the American economy is by far the strongest in the world. Accordingly, I have directed the Secretary of the Treasury to take the action necessary to defend the dollar against the speculators. I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold or other reserve assets, except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.”

– President Richard Nixon’s address to the nation, 15 August 1971.

Notice that word “temporarily”? Well, as it turned out, it was permanently. Thanks to the Bretton Woods Agreement, which was introduced after World War II, the dollar was backed by gold, and all other currencies were pegged to the dollar. Since Nixon suspended the convertibility of the dollar to gold, the tie to gold for the whole world was effectively broken. And so we entered into the age of fiat currency – the softest money we’ve ever had, controlled by governments and central banks (and by extension the wills and whims of those at the helm of these institutions).

Humanity’s money has changed and morphed throughout history based on relative scarcity and the technological capabilities of the time. Since our tie to gold was broken in 1971, money is no longer scarce. It is being created with no particular expenditure of time or energy at the discretion of global governments and central banks. It’s all heading in one direction, sharing the inevitable fate of all fiat currencies throughout history: hyperinflation and ultimately, worthlessness.

This form of money has profound implications on the state of society itself: rampant consumerism and short term preferences are a natural result of a form of money that incentivises immediate gratification (i.e. our collective time preference as society becomes higher and higher – we increasingly tend to neglect the longer-term consequences of our decisions in favour of the short-term).

Where do we go from here?

The global fiat monetary experiment celebrates its 50th birthday in August 2021. Perhaps we should rather consider it the 50th anniversary of the gold standard being hacked. This seems more apt (and less celebratory).

Here is the main problem with having a select group of people able to control something as powerful as money itself: the temptation to breach the trust of the masses and abuse this power for personal gain is too great to resist. As the old adage goes: “Power tends to corrupt and absolute power corrupts absolutely”.

In the next instalment of The Melting Ice Cube Series, we take a closer look at inflation from a numerical perspective and how seemingly small figures, compounded over time, melt the ice cube at an ever-increasing rate.

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Two young fish are swimming along when they happen to meet an older fish swimming the other way, who nods at them and says “Morning, boys. How’s the water?” The two young fish swim on for a bit, and then eventually one of them looks over at the other and says, “What on earth is water?”

The moral of the story is that we do not always understand the fundamental nature of things that surround us every day. Just as the younger fish did not have any concept of water, many people today do not fully appreciate the nature of that thing that is so ubiquitous to us humans – money.

Here, at the dawn of a new decade, humankind faces a predicament when it comes to money:cash, the simplest form of money, is losing value faster than ever before. This will affect businesses and individuals alike, especially if we are unaware of the fact that it is happening.This series of blog posts attempts to uncover the ways in which businesses can mitigate the effects of the rapidly declining purchasing power of cash.

Cash: a melting ice cube

Money is a technology. It has evolved over millennia to facilitate exchanges of value between people, and to store that value over long periods of time to be used as and when the holder of that money sees fit. We’ve seen various iterations and manifestations of money over the years: shells, precious stones, glass beads, gold, and, most recently, government-issued “fiat” currency.

Fiat currency is not backed by a physical commodity but relies on a shared faith in the power it holds. Being disconnected from a commodity means that the purchasing power of fiat currency can vary. Inflation results in the purchasing power of fiat currency dropping, and this means that you get less bang for your buck.

Many people are surprised when they learn that the world’s currencies are no longer backed by gold reserves. This is why, since the outbreak of Covid-19, central banks the world over have been able to stimulate the economy by creating new cash and injecting it into the economy. The Federal Reserve in the United States has created around $9 trillion since March 2020. To give you an appreciation for the scale of that injection, approximately 20% of all dollars that have ever existed were created last year.

This is shocking, and it has a direct impact on every person and business holding cash. This is because the purchasing power of cash, in real terms, is being diminished at an alarming rate. Cash has steadily lost purchasing power to inflation over the last 50 years, and the rate of loss is now increasing more and more rapidly. Michael Saylor, founder and CEO of MicroStrategy, has dubbed this a “melting ice cube”.

The decline in purchasing power of the US dollar between 1913 and 2019.

Creating a buffer

If your business holds significant amounts of cash on its balance sheet, you may need to consider creating a buffer against incoming inflation to prevent erosion of the value that your business has already created.Monetary inflation and “quantitative easing” by central banks is a surreptitious force which steals time and value from businesses and citizens alike by inflating away the purchasing power of the cash that they hold. This may have sounded like a conspiracy theory ten years ago, but now it is becoming a fact that most economists and “finance people” agree on.

The question arises of what to do about this precarious situation. Clearly, we must take some form of defensive action against the approaching inflationary storm. Ignoring these economic realities in the hope that it sorts itself out is not a proactive strategy. In fact, it is no strategy at all. First, we must be aware of the underlying problem. Then we must formulate a solution.

A business needs cash on hand to move quickly, and to be flexible and responsive on short notice to changes in the external environment. The cash a business holds on its balance sheet is like an internally generated insurance policy to deal with unforeseen circumstances in the short term.

Varying degrees of accessibility

Now, this “insurance policy” need not be held 100% in the form of cash in the bank. It can be broken up into tranches of various degrees of liquidity and accessibility, depending on the needs of the business.

For example, if a business holds three months’ worth of operational expense cover in cash, it can be held in different forms, ranging in short-term accessibility. The table below shows an example of this type of diversification.

An example of the forms in which a business can keep cash, ranging from most accessible (top) to least accessible (bottom).

The example above is by no means prescriptive. Each business should consider its own position and requirements, and develop a strategy accordingly.

The concept behind this table is that each block represents a percentage of the total cash held by the business, starting at the top. A bucket of water makes a useful analogy – we scoop from the top first, not from the bottom. The top of the table is the most immediately accessible, the middle slightly less so (perhaps the money market account has a 32-day notice period in order to yield a higher return), and the bottom is the least accessible, and also the least likely to be required in the short term, if ever.

The chances are lower that a business would need to dip into the darker shades, and so that cash can be converted into a form that will produce a strongerhedge against inflation since the likelihood of having to draw on it is much lower over the long term.

The opportunity cost of holding the entire operational expense cover in cash, however, is very high. The lower levels of the reserve might never be touched, but it is still prudent to hold this internal buffer within the business. The form in which it is held is important, and each alternative will come with its own set of pros and cons. These need to be considered in detail by the business before making an allocation to a specific inflation hedge.

More to come

The Melting Ice Cube Series will attempt to explore the intricacies of the phenomenon of the loss of purchasing power of fiat currency during the first quarter of 2021, at a time when awareness of these larger global economic forces is more essential than ever before.

We hope that you will join us on this inquiry over the next few months. The greater macroeconomic realities with which we are faced at the present time affect us all – both personally and on a business level. In order to navigate this potentially turbulent and volatile time, we must keep an open mind and be willing to learn and explore avenues which, up until now, were considered non-essential “nice-to-haves”. Very soon, they will be critical.

As we look ahead at the year and decade which lies before us, we may be filled with uncertainty, worry and even fear – but there is always hope. Arming ourselves with knowledge and education will be our best chance of collectively navigating ourselves towards greener pastures and a brighter future.

Let’s make the journey together.

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Key Performance Indicators do just what they say on the box; they indicate how well your business is performing in key areas. If we liken a business to a vehicle, KPIs are the dashboard. They can answer questions such as: How fast are we going? How much fuel is in the tank? Should we change gears?

Just as you would check your car’s dashboard while you drive, so you should also keep an eye on your KPIs as a business.

“Key Performance Indicators indicate how well your business is performing in key areas.” 

Although KPIs are not compulsory, they should be included in a management report pack where they can be regularly viewed and, where necessary, investigated.

Designing your KPIs

When designing a set of KPIs for your business, you should ask the question: “What information do we need to make decisions based on the core operations of the business?”

This enquiry should be your point of departure and the KPIs will naturally emerge from the answers to this question. Answering this question will also help you to crystallise a deep yet simple understanding of the nature of the business.

Less is more

There is always the temptation to overcomplicate the KPI creation process. This often leads to a myriad of vague KPIs across the board, most of which will be of little use in making mission-critical decisions. Moreover, a weak set of KPIs will inevitably dilute crucial insights. We should guard against this over-the-top approach. KPIs are, after all,  key  performance indicators.

To return to the vehicle analogy, the dashboard shows you only the most important readings for your car. A cluttered dashboard is distracting and essentially useless because the crucial indicator should be evident at a glance. The same applies to KPIs for your business.

In order to whittle down the various indicators, we need to align our priorities and focus on the few measures that are truly indicative of the performance of the business. The idea is to be able to answer this question at all times: “Are we winning or are we losing?”.

“We need to align our priorities and focus on the few measures that are truly indicative of the performance of the business.”

Keeping score

Behavioural psychologists have proven that people play a game very differently when scores are being kept. In this sense, KPIs can be used as the scoreboard within an organisations’ incentive structure to motivate the team to play harder and assume more ownership of their deliverables and responsibilities. Everybody wins, and when they know they are winning, that is good for the whole business.

“KPIs can be used as the scoreboard within an organisations’ incentive structure to motivate the team.”

When designed correctly, these incentive structures can lead to positive feedback loops within the organisation. This has the potential to unleash greater human ingenuity, which is arguably one of the most valuable commodities in any organisation.

Lead, don’t lag

In their book   The Four Disciplines of Execution  Sean Covey and his team make a distinction of particular relevance to KPIs: the idea of lead and lag measures.

Lag measures  are reported after the fact. They typically shed light on what has already happened. Little attention is paid to the causal factors of this historical data. By contrast,  lead measures  are predictive and future-orientated. So while lag indicators look backwards, through the rear-view mirror, lead indicators look forward to the road ahead. In essence, lead measures are proactive, taking initiative for the future journey.

“Lag measures are reported after the fact; lead measures are predictive and future-orientated.”

Let’s use the vehicle analogy as an example. Our lag measure is revealed when we do a roadworthy test. Let’s say the car failed the roadworthy because the tyres are slick and one brake light is broken. The lead measures in this example are regular service check-ups on the car, to ensure that broken lights get fixed and tyres are in good order. When we concentrate on lead measures (regular car services), we can be more confident about the lag measure of “roadworthiness”, and that our vehicle will pass the test.

To put it simply, attaining lead measure targets invariably leads to the attainment of lag measures. This is far better than looking at a lag measure of, for example, revenue growth at the end of each month, and hoping that it will look better next month. Instead, we should be focused on lead measures, for example, reducing machine downtime through routine preventative maintenance. We predominantly want to make use of lead measures because this puts us in control.

Qualitative and quantitative indicators

Not all KPIs need to be finance-orientated. In fact, it’s a good idea to have a blend of both quantitative (hard numbers) and qualitative (softer and more subjective, but still measurable) indicators.

Quantitative indicators  will zoom in on things like revenue growth, machine downtime and physical output.  Qualitative indicators  bring awareness to the more subjective and ethereal dimensions of the business. This includes customer and employee satisfaction and motivation levels, the success of training programs and awareness campaigns, as well as other elements which are harder to quantify in absolute terms. Although they are slightly more difficult to measure, however, we should not neglect them.

“Quantitative indicators focus on things like revenue growth and physical output, while qualitative indicators bring awareness to things like customer and employee satisfaction and motivation levels.”

There are significant lead measures to be uncovered on the qualitative side of the KPI dashboard. Take the time to figure out how best to collect the data to gain these insights. As an example, Creative CFO uses OfficeVibe to gauge the morale of its team anonymously. It is a great way to keep tabs on the more subjective side of running a business, which can be just as illuminating as the hard data.

Final thoughts

When identifying a business’ KPIs, what are the key takeaways?

  1. Keep it simple. When designing your KPIs, distil them down as much as possible to gain only the most essential and illuminating insights.
  2. Are we winning or losing? Ask this question of every KPI.
  3. Lead, don’t lag. Concentrate on being proactive and focus on lead measures that will invariably help you achieve your lag measure targets.
  4. Blend qualitative and quantitative indicators. Don’t focus exclusively on hard statistics, but look at the affective aspects of your business performance too.

Ultimately, every set of KPIs will be as unique as the business that designs them. They should be tailored to reflect the key drivers of value, as well as the best way to interpret these. The process of building out a business’ KPI dashboard should take time and careful reflection, which can be seen as an exercise in setting priorities.

Business owners have often been impressed by the clarity and decision-making capabilities that emerge from this exercise. Moreover, the exercise empowers business owners to initiate effective action to take their organisation from strength to strength.

No matter the size of your organisation, there will be those few key indicators of unparalleled importance. Identify them, track them, refine them, and let them lead your decisions.

If you require some assistance in this process, please reach out to us. We would be happy to cast a KP-eye over things.

Happy reflecting!

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The cash flow statement is the final piece of the puzzle when it comes to the monthly management reports that we prepare here at Creative CFO. This is without a doubt one of the most important and often overlooked financial reports within the monthly report pack.

The cash flow statement in context

The profit and loss statement, discussed in an earlier blog, provides information on the revenue and expenses over a certain period of time. This is used alongside the balance sheet, which gives a snapshot of the financial health of a business. Out of the information from both of these reports, the cash flow statement is born.

Cash is the heartbeat of a business. A business requires cash to be able to pay its suppliers, vendors and employees, but it also needs cash to be able to invest back into itself in order to grow. The cash flow statement can show how effectively a business is managing its cash inflows and outflows over a specified period of time. This is particularly important to investors seeking to determine the short-term viability of your company, particularly its ability to generate cash and pay bills.

In accounting terminology we often refer to “accrual versus cash accounting”, and this really sums up the importance of understanding the cash flow statement and how it can be utilized to grow your business. “Accrual versus cash” refers to the method in which a report is drawn up. Accrual accounting reports on revenue when it is earned and expenses when they are incurred. Generally, your profit and loss statement is drawn up on the accrual basis. This means that you could earn revenue by invoicing your customers and this will reflect on your profit and loss statement, but until cash changes hands and you receive the money in your bank account, it will not increase your cash immediately. In essence, profits do not always equal cash.

When we look at our monthly reports, it is common to go straight to the balance sheet to see what the bank balance was at month end. However, it does not necessarily tell you how it came in or went out during the month.

Breakdown of the cash flow statement

Let’s take a closer look at the components that make up a typical cash flow statement by using the example below.

Based on the indirect cash flow method, we will start with the operating profit/loss which is pulled directly from the profit and loss statement. This is then adjusted to take into consideration non-cash movements, as well as cash movements, to reconcile at the end of the report with the actual cash balance that you have in the bank at a specific month end.

Depreciation and amortisation are always adjusted for, i.e. added back, as no physical cash leaves the business for these transactions. The only time that cash is affected is when we actually buy the asset. Depreciation and amortisation simply show how the expense is allocated over its useful life.

We can then split the rest of the report into three main sections:

1. Cash generated from operations

This is such an important section of the cash flow report as it showcases how the core of your business is generating and utilizing cash. If we take a look at the movements that are represented in the above image, we can establish how these movements affect the amount of money we have in the bank.

For example, if we take a look at the (increase)/decrease in trade debtors – this would be your customers whom you have invoiced, and if this figure increases then we adjust the net income by deducting the increase, and if it decreases, we adjust with a positive figure.

At the end of the cash flow from operations, you ideally want to see a positive number here, otherwise the company is not raising its cash from its core business activities which could raise a couple of red flags. One of the most common causes of this could be that your cash is tied up – you are perhaps giving your customers long payment terms or your receivables are very overdue – which means you have to continue paying your expenses and suppliers before you have actually received the cash from your customers.

2. Net cash from investment activities

This is cash spent or received from investments, which is outside the core of the business. If you perhaps purchase a new asset or purchase shares in another company this will be reflected here.

3. Net cash from financing activities

This represents the raising, borrowing or repaying of loans and issuing of new shares or dividends paid, to name a few. If you receive a loan from the bank, the cash comes in, so this will be represented as a positive amount on the cash flow statement. This is then easily identifiable to the person reading the report that money has come in. When the company repays the principal portion of its loans, this will be presented as a negative amount, which means that cash was used which reduces the bank balance.

Managing cash flow is vital for business success, it really can be summarized as doing anything and everything possible to ensure money is coming into the business as quickly as possible and exiting as slowly as possible. In order to summarise the cash flow statement visually we use the waterfall representation as part of the monthly management reports, an example of which is below.

Tips for getting the most out of your cash flow statement

To end off, we will leave you with a few of our top tips to keep in mind for when you are next reviewing your cash flow statement and forecasting for the upcoming months:

  • Profit does not equal cash, so don’t count income until it’s in the bank.
  • Plan for the unexpected. Before you purchase that awesome new coffee machine, make sure you have cash in the bank to cover at least two months’ operating expenses.
  • Be prepared for growth. When a business grows, it more often than not comes with additional costs which can include marketing, buying additional inventory or on-boarding additional resources.
  • Line up your invoicing and collections. Too many small businesses land up with customers with long outstanding debts. Make sure to stay on top of your debtors or implement a debit order system from the start.
  • Always have an up-to-date cash flow forecast. It is vital to know what your cash commitments are for the upcoming year.

The cash flow statement is one of the most integral components of the monthly management report pack that Creative CFO provides. Now that you know what it means to have an up-to-date cash flow statement, get in touch with us to discuss your business’s financial reporting needs.

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A balance sheet is a document that outlines the business’s value. It does this by listing three main things: the assets that a business owns, the liabilities that a business owes, and the equity, which is the assets less liabilities.

The balance sheet forms part of the management report pack that Creative CFO produces. Often, the balance sheet can be quite challenging to understand, so we have made it our mission to make it visually understandable.

What is the purpose of a balance sheet?

The purpose of a balance sheet is to give interested parties an idea of the company’s financial position, in addition to displaying what the company owns and owes. It is important that all investors know how to use, analyze and read a balance sheet. A balance sheet may give insight or reason to invest in the business.

Components of the balance sheet

The balance sheet consists of three main components:

  1. Assets – what the business owns
  2. Liabilities – what the business owes
  3. Equity – this is assets less liabilities and represents the accounting business value.

What does a healthy balance sheet look like?

Every business owner wants to know that their balance sheet is looking good. But what exactly does this mean? We have recorded a short video to explain.

What steps can be taken to improve the balance sheet?

When a business’s balance sheet is not looking too healthy, the business owners might consider taking some steps. The balance sheet can be improved in a couple of ways. Some steps can be taken immediately, but mostly the business owners have to put longer-term strategies in place to ensure positive change in the business’s financial position.

If the strategy of the business is to improve equity and make the business more attractive for potential investors, the following steps can be taken:

Immediate actions

  1. Pay close attention to inventory control
  2. Improve debt collection days
  3. Review all business expenses and ensure that the cost are needed to increase profitability
  4. Review procurement strategy and negotiate with suppliers for better rates
  5. Look for “low hanging fruit” opportunities in terms of sales.

Longer-term actions

  1. Put a strategy in place to see how debt can be paid off faster
  2. Review underperforming assets and consider selling if necessary
  3. Ensure the business stays cash positive and saves for a rainy day.

When is a business insolvent and what does it mean for directors?

One important use for a balance sheet is to show whether or not a business is insolvent.

A business is insolvent when its total liabilities exceed its total assets. In other words, the business owes more than it owns. This shows that a company is in financial distress.

The Companies Act 71 of 2008 defines “financially in distress” in section 128 (f) as:

  1. reasonably unlikely that the company will be able to pay all of its debts as they fall due and payable within the immediately ensuing six months, or
  2. reasonably likely that the company will become insolvent within the immediately ensuing six months.

There are two types of insolvency:

  1. Technically insolvent: Liabilities are more than assets (fairly valued)
  2. Commercially insolvent: A business is unable to pay its debts even though the assets may exceed liabilities.

It is the directors’ responsibility to assess insolvency and to ensure that the business will be able to continue as a going concern in the foreseeable future. Should there be warning signs of the business not being able to continue as a going concern directors need to take immediate action by seeking legal and financial advice. Should a director not take the necessary steps, they may be held responsible for losses incurred.

When is the best time to get a balance sheet?

Now is the best time to get a balance sheet, but more importantly any business should monitor their balance sheet on a regular basis and the goal should be to improve the balance sheet. Creative CFO is well equipped to prepare a balance sheet for your business.

Speak to our  helpful consultants they are available for your reporting and business processing needs.

👉   READ: Part 4 – Understanding and achieving a healthy cash flow

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The profit and loss statement (or P&L in accounting jargon)  is arguably the central management statement for most SMEs, recording the majority of operational activities over any period of time, usually monthly. Ranging from the total revenue received to all the expenses incurred by the business over the period, the P&L is a treasure trove of information for any business owner.

This article aims to provide a detailed explanation of the role of the P&L, what information it contains, how to use it to determine an array of essential business health indicators, as well as how to set up a simple, well-tailored P&L structure for your own business.

BASIC FORMAT OF THE P&L

Modern cloud-based accounting platforms allow for sleek and elegant layouts of the P&L. Modern platforms also mean that it can be built in a highly customisable way, tailored to the specific needs of the business owner. The five main sections of the P&L are shown below. This is the most essential, bare-bones P&L format and really tells us only two things: How much money came in, and how much money went out.

The P&L’s skeleton is shown below:

Now that the skeleton is in place, we can start to flesh things out a bit.

We can add different revenue accounts for various income streams, or set up tracking categories – but more on this later. We can also create cost of sales accounts that show the direct expenses incurred to generate specific revenue items, as well as the other general expenses and overheads (OPEX) which the business has incurred over any given period of time, ranging from rent and salaries to staff welfare and entertainment.

GUIDING PRINCIPLES

Someone once said, “It ain’t simple being cool, but it’s cool being simple”, so keep it simple and avoid an overcrowded statement. Analyse your business’s revenue streams and major expenses and design your P&L layout accordingly. Keep the focus on the most important thing.

For revenue, ensure that you have a streamlined process for your invoicing and payment platforms. Cloud-based accounting tools are brilliant at setting up connections and integrations (called APIs) with other cloud-based tools and applications. It’s like one big ecosystem of chattering computer applications floating around in the cloud. Setting up your revenue and invoicing processes to be automated as far as possible is a great help towards the overall integrity of your business data. It also saves an incredible amount of time!

The same applies when capturing expenses through platforms like Receipt Bank – a simple system can go a long way in ensuring the accuracy and completeness of your P&L’s expense information. Clean revenue and clean expenses. Fantastic!

ANALYSING THE P&L: FROM DATA TO INFORMATION TO KNOWLEDGE

The management gurus are forever telling us to “measure what matters”. This applies to the P&L too. You can use the data from the P&L to identify key performance indicators rather than a myriad of confusing technical data. Determine what is really important and do not settle for standardised, generic reports.

The true value of the P&L is realised when relevant information is identified from within the report, turned into knowledge and used to the business’s advantage. Based on the industry, age, size and goals of the company, various key ratios can be determined. Using the correct software to prepare your statements will also simplify these ratios. Ratios can be presented and interpreted easily by converting them into colourful graphs and diagrams.

As an example, in service-based industries, salaries generally make up the largest portion of monthly expenses. From the profit and loss statement a revenue-to-salaries ratio can be determined. This provides business owners with valuable insight into their ability to pay salaries when revenue decreases.

An example of a revenue-to-salaries (in this case, revenue-to-wages) ratio is shown below:

A few basic questions to ask ourselves could be:

  • How is revenue growing?
  • What is the general gross profit % of the business?
  • What portion of monthly revenue goes to covering overheads and other expenses?
  • What are the main monthly overheads?
  • What is our “baseline” overhead expenditure on a monthly basis?
  • What does the bottom-line (the net profit) look like, month-on-month?
  • Where can we eliminate unnecessary costs?

The 80/20 rule (also called the Pareto Principle) can be easily applied and often delivers fantastic insights to hidden or obscured information. It is a surprising universal law that works well in the context of the P&L. Using the Pareto Principle, ask yourself some of these questions when looking at the P&L of your business:

  • Which clients are responsible for 80% of revenue?
  • Which products/services are responsible for 80% of revenue?
  • Which expense line items account for 80% of the monthly cash outflow?
  • Which marketing tools bring in 80% of the revenue-generating leads?

This is by no means an exhaustive list, but it should get you thinking in terms of this mysterious universal law. Try it, you might be amazed at the insights that can be gleaned from this simple approach.

XERO’S ADDITIONAL USEFUL FEATURES

As mentioned previously, the P&L consists of two main components: revenue and expenses.

Our revenue’s data integrity will come down to how well the invoicing function is run in Xero. Set up “Item Codes” for each product or service to ensure that invoicing is quick and easy, containing all the necessary information relevant to the product or service being sold.

Tracking Categories can also be created to assign both revenue and expenses to certain products, projects or services for “per product” reporting. Tracking Categories is a powerful tool to segregate different segments/departments/products/services and so on within the business to gain visibility on them in isolation. Reach out to us if you need help setting this up.

Once again, you don’t want to create administrative burdens by incorporating excessive detail which will result in you drowning in the complexity of your own design. Keep it as simple as you can.

FINAL THOUGHTS

A picture is worth a thousand words, and if that is the case, the P&L is worth ten thousand. It speaks volumes about your business. A customised report tailored to your specific business model is an invaluable source of information for timely and informed decision-making.

P&L’s of the 20th century contained all manner of boring and generic “accounting-speak”.  Luckily for us, in the 21st century, there is a lot more freedom in how businesses are defined.

The P&L is undoubtedly an essential statement for any business owner to read and understand at a glance. Let’s make the once-off investment of setting it up beautifully at the outset to reap the benefits in the long term. The P&L has profound insights to offer on your business if it is designed well. The name of the game is management through conscious business design, and the modern marketplace demands it.

Speak to our helpful consultants , they are available for your reporting and business processing needs.

👉  READ: Part 3 – An Explanation of the balance sheet for business owners

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The purpose of a management report is typically to gather data from the various parts of a business in order to report back to management on certain key performance indicators (KPIs). Business owners and stakeholders often rely on timely and relevant reports for strategic decision-making and goal setting.

In a time when businesses and stakeholders are increasingly adapting to the automation and digitisation of processes, management reporting has begun to take on a new meaning. Because of automation and digitisation, management reporting can now seamlessly form part of a business’s everyday operations rather than being a time-consuming side project. This means that time and energy is not spent on laboriously putting together a management report that could still be riddled with errors. Automation has made this process almost instantaneous and far more accurate.

HIGH-QUALITY MANAGEMENT REPORTING

Management reports are only a useful tool if they are done properly; a poorly prepared or presented management report can be frustrating and misleading. The following attributes are fundamental for high-quality management reporting:

  • Accuracy 

Accuracy is driven by the quality of the input data and processes used to generate the management reports. Efficient automation relies on robust checks and balances built into the system.

  • Timeliness 

Management reports are only as valuable as they are relevant and timely. It is imperative that the framework used for drawing up management reports should be adaptable, so that a change in the inputs or format can be adopted swiftly without compromising deadlines in the reporting process.

  • Relevance 

Typically, daily processing, operations and risk assessment functions are carried out at various levels of the business. Depending on the size of the business, directors and owners may be far removed from the day-to-day functions, focussing instead on higher level strategy and goal setting. This separation of duties makes it all the more necessary to ensure that dashboards, ratios and analyses presented in the management reports are useful for the decision maker who may be far removed from the granular detail on the ground.

THE EFFECT OF AUTOMATION ON THE MANAGEMENT REPORT

For a small business operating in a high-pressure environment with limited segregation of duties, the requirements for a good management report can seem daunting. Luckily, automation helps with all three aspects.

Business owners may view operational processes and management reporting as conflicting priorities, and they may choose to focus on the former. Again, automation eliminates this dilemma. In this way, automation can be viewed as an enabler of good practice.

Below are some examples of business process automation. The resulting efficiencies materialise in timely, relevant and accurate management reporting:

  • Automated, real time bank feeds to replace manually captured of bank statements,
  • Digital sign off of invoicing and expenditure,
  • Electronic logbooks,
  • Automated prompts to signal  required action for individual and team tasks.

MANAGEMENT REPORT FORMAT

So what does the perfect management report look like? Whilst there is no prescriptive management report format, there are guidelines for representing effective management reports that add real value.

Management reports will typically comprise the following:

  • Executive summary
  • Statement of financial position*
  • Profit and loss statement*
  • Cash flow statement*

*These will be covered in future articles in this blog series.

EXECUTIVE SUMMARY

The executive summary provides the reader with the key highlights for the reporting period. A well-presented executive summary should paint an accurate and concise picture about the following:

  • Key focus areas and the action required
  • Financial position
  • Key performance areas and metrics
  • Operations
  • Overall strategy
  • Product and/service
  • Team

The executive summary is therefore a snapshot of the entire management report and sets the tone for  key discussion areas in the management meeting.

MANAGEMENT MEETINGS

Management meetings present the opportunity for active engagement between management and the financial advisor. This in turn directs the strategy that will be applied at various levels of the business.

As with any piece of literature, certain aspects of themanagement report may be open to varying interpretations, hence the need for alignment and discussion in a management meeting.

Management reports play a crucial role in weaving together the results of daily process, performance and reporting across all pillars of business. They present the big picture and provide the clarity that business owners need in an increasingly dynamic world.

Speak to our helpful consultants , they are available for your reporting and business processing needs.

👉 READ: Part 2 – A business owner’s guide to understanding and working with the profit and loss statement

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While the pandemic has forced many employees to work from home, you may be wondering if you now qualify for the home office tax deduction. We outline the requirements for employees to qualify below.

Requirements to deduct home office expenses

  • You are currently employed and working for a salary / commission
  • You are required by your employer to work from home
  • You have an office / area that is used regularly and exclusively (more than 50%) for your work i.e. the kitchen counter would not suffice
  • Your office is specifically equipped for purposes of the trade e.g. fitted with a desk, computer and printer

What expenses can you deduct?

  • Rent
  • Interest on bond
  • Rates and taxes
  • Cleaning
  • Wear and tear
  • Repairs to the office
  • Other expenses relating to the office

Ifmore than 50% of your remuneration is comprised of commission you can also deductcommission related business expenses i.e. telephone, stationery, repairs to printer etc.

How to calculate home office expenses

If the expenses relate to the residence as a whole, the expense must be apportioned as follows:

A/B x total costs, where

  • A = The square metre area used for work
  • B = The total square metre area (including any outbuildings and the area used for work) of the residence
  • Total costs = the total costs incurred for the acquisition and upkeep of the property (excluding expenditure of a capital nature)

If the expense is a specific business expense then the entire cost is deductible.

2021 tax year 

If you have been working at home due to COVID-19 you will only be able to claim this deduction for the 2021 tax year if you will have worked from home for at least 6 months of the tax year and meet the requirements above.

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In response to COVID-19, SARS has re-designed the 2020 tax filing requirements for individuals.  Some material changes have been made to simplify the process and remove the need to visit SARS branches in an aim to become more efficient and observe social distancing.

Through the increased use of third-party data, SARS will be completing your tax return for you. Where SARS has the required information they will provide you with a proposed auto-assessment without the need for you to file a tax return. This enables you to view, accept, or edit your proposed assessment online using eFiling or SARS MobiApp.

The 2020 tax season (period 1 March 2019 to 29 February 2020) for individuals will open 1 June 2020 and it will be staggered as follows:

Auto-Assessments
1 June 2020 – 31 August 2020 SARS will issue auto-assessments based on third party data (e.g. employers, medical aid, pension funds, etc) and provided claims are not anticipated (e.g. travel allowance). Taxpayers have the opportunity to accept auto-assessments or not as per below:

  • During August auto-assessments will be issued and taxpayers will be notified by SMS
  • Taxpayers have the opportunity to confirm acceptance of the auto-assessment afterverifying the accuracy OR if you do not agree with the results or anticipate claims you can edit the information and resubmit your income tax return from 1 Sept
  • If you accept the auto-assessment under or overpayments will be processed as normal
  • Taxpayers who are NOT required to file will be informed – details to be advised
  • Taxpayers who are required to file from 1 Sept will also be informed – details to be advised
Filing 
1 Sept 2020 – 16 November 2020 Non-provisional taxpayer eFiling
1 Sept 2020 – 22 October 2020 Non-provisional taxpayer Branch filing by appointment
1 Sept 2020 – 29 January 2021 Provisional taxpayer eFiling

It is important to note that SARS will be relying on data collection from both local and international third parties.

Creative CFO welcomes this trend towards automation if it saves you time and money, and we see this as the first step towards future digital submissions. We are here to assist you in navigating these changes and make the most of the new technology.

If you have any questions please contact our Tax Team here.

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