Striking a Balance: Monthly Reconciliations and Profit and Loss Analysis
In the world of business accounting, two critical practices stand out for ensuring clarity, accuracy, and long-term financial health: monthly balance sheet reconciliations and profit and loss (P&L) comparisons.
We’re looking to answer a few questions:
- are your assets and liabilities accurate and complete?
- are your income and expenses accurate and complete?
- are you consistent and correct with your bookkeeping?
- what can you do with this knowledge to improve your business?
Balance Sheet Reconciliation
Reconciliation is a process of aligning your business records with real-world figures, ensuring no discrepancy remains unchecked. That is, your balance sheet should accurately record the assets and liabilities of your business. Here’s how it’s done based on common balance sheet items:
- Bank Accounts: Begin by comparing your bank statement with your recorded cash account. Are there any differences? They could be due to double entries, outstanding receipts or deposits not yet reflected on your statement. Adjustments may be required for bank fees or any other discrepancies.
- Credit Cards: Ensure that the credit card liability on your balance sheet aligns with your actual credit card statement. This step requires close attention to any pending charges that may not have cleared yet. Have you paid your credit card to avoid high interest? If so, the balance in your accounts should clear to nil. If not, do you have a cheaper source of finance?
- Accounts Receivable: This figure should match the total of outstanding customer invoices recorded in your system. If old unpaid invoices linger, don’t just let them sit there but assess whether they need to be written off or followed up.
- Inventory: Regular physical counts of stock ensure your inventory’s book value aligns with what’s on hand. Any mismatch could point to issues like theft, spoilage, or recording errors.
- Fixed Assets: If you’ve made significant purchases like machinery, equipment, or vehicles, it’s essential to update these in your books. Ensure to adjust for depreciation, and account for any sales or disposals of assets during the month.
- Accounts Payable: Cross-check that the pending bills in your records match the accounts payable on your balance sheet.
- Loans: The outstanding loan amounts should correspond with your records, including interest accrued.
- ATO Balances: Ensure the GST, PAYG, or any other tax obligations on your balance sheet match what’s owed according to the ATO. For more detail, you might like our article on managing your BAS
- Superannuation: The ‘Super Payable’ account should match the total super obligations accrued for your employees that haven’t been disbursed yet. Make sure you pay super on time – the costs and penalties for late payment are horrendous!
Best practice is to create a reconciliation file where you keep a record of the supporting information for your balance sheet accounts. At the end of this process, have a look to see it makes sense. If you have items that don’t make sense then put time aside to investigate further so that you understand why the balance exists or fix it if it is incorrect.
Decoding the Monthly Profit and Loss Comparison
After you have completed your balance sheet reconciliation, comes the important aspect of reviewing your profitability. P&L comparisons aren’t just about tracking profitability; they’re about identifying inconsistencies, ensuring data accuracy, and enabling informed business decisions. A monthly deep-dive can reveal anomalies, coding inconsistencies, and provide insights for strategic planning.
1. Run the Numbers: Start by generating a Profit and Loss statement for the current month. Your accounting software will allow you to run a report over custom periods; utilise this to compare the current month against previous periods, we often use the last 11 months. This year-long perspective offers both a macro and micro view of your financial health.
2. Spot the Trends: Carefully analyze your revenues and expenses month over month. Are there noticeable patterns? Perhaps sales are seasonally stronger in certain months or you notice a steady uptrend in a particular revenue stream. Recognizing these trends can guide you to focus areas so your management actions improve your business.
3. Consistency Check: Some expenses, like rent, utility bills, or phone bills, recur monthly and should therefore be consistent. If an expected expense is missing or unusually high or low in a particular month, it warrants a closer examination. Such discrepancies can be an indication of a missed entry, possible error or over charge.
4. Delve into Expense Changes: Significant variances in any expense category could indicate coding inconsistencies. For instance, if the same expense is categorized differently from one month to the next, it will distort month-over-month comparisons. Consistency in coding is key for accurate financial analysis.
5. Reasonability Test: While the numbers might technically add up, do they make sense intuitively? If, for example, your travel expenses have spiked but you haven’t attended any conferences or business trips recently, there may be an error or an unauthorized expense.
6. Evaluate Recurring Expenses: Many businesses have subscriptions or services they once needed but no longer utilize. Regularly review recurring charges to ensure they’re still relevant. Perhaps there’s software you no longer use, or a subscription service that can be downgraded. Eliminating redundant expenses can lead to significant savings over time.
7. Engage in Proactive Decision-Making: Armed with a monthly comparison, you can better understand your business to make informed decisions. Perhaps you notice that advertising expenses have increased, but revenues have remained stagnant. This could prompt a review of your marketing strategy. Conversely, if you spot a particular revenue stream growing consistently, it might be worth further investment.
In essence, a monthly P&L comparison is more than just an exercise in data review; it’s a strategic tool that, when used effectively, can drive business decisions, foster growth, and ensure financial stability. By following this systematic approach, businesses can not only detect anomalies but also seize opportunities and make forward-thinking choices.
You can do this yourself, however you will do it better with professional help on either the bookkeeping or a review discussion to assess your results and future planning. At Porters CA – Chartered Accounts we provide bookkeeping services and our accountants and Directors can provide insight and feedback to help improve your business understanding and performance. Contact us to find out more.