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Reasons for monitoring business performance

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In order to plan and control the running of a business, it is necessary to be able to identify the kinds of information that accounts can give, and how these can be interpreted to show how well a firm is doing.

Accounts can provide a way of monitoring:

Solvency: whether or not a firm has enough assets (both fixed and current) to be able to trade into the future. For example, if a firm is short of cash, it may not be able to meet its debts and be forced to sell off fixed assets, such as machinery and vehicles. Cash flows can be monitored and forecast in order to make provision for periods when cash may be short.

Profitability: profit is one of the most significant measures of business performance. A firm will judge how well it has performed compared to past profit levels and to those of other firms in the industry.

Achievement of targets: for example, has the firm achieved its target of a 10% increase in profits, a 5% growth in its market share, a 20% cut in operating costs, cut bad debts in half, etc.? Financial information can be used to identify areas where an organisation can improve its performance. Actual results can be monitored and action taken if the firm appears to be off-target.

Tax: a business can monitor and prepare for the amount of tax due to be paid to the Inland Revenue and Customs and Excise department.

Financial requirements: a business must monitor loan and credit repayments and make sure they do not fall behind, as this may jeopardise any future requests it makes for loans or credit.

Performance: a business can compare its performance over time and with rival firms in the same industry and other industries.

Accounting information can also be used to identify trends and forecast future performance: in order to make an informed guess at the future performance of a business, it is useful to look at its past performance and see if there are any trends which might be expected to continue into the future. For example, if sales have on average risen by 10% each year, one might reasonably forecast sales to rise at this rate in the future. However, the past is not always the best guide to what might happen in the future. Market conditions are constantly changing. New suppliers entering the market, shortages of raw materials, changing consumer demand, new government policy – all these factors and more can affect the performance of a business. Judgement is, therefore, required.

During the course of each trading period, a business will continually monitor whether or not it is ‘on target’ to achieve its objectives. If the firm is ‘off target’, or under-performing, managers can make changes to the operation of the business in order to move the firm back towards its goals. For example, a firm selling chocolate bars may aim to capture 25% of the market by the end of the year. To do this, it forecasts it must increase sales at 5% each month. If, midway through the year, sales of its chocolate bars are low and are being outstripped by sales of a competitor’s product, the firm may plan a new advertising campaign to raise sales, or may even lower price to boost demand. Plotting actual sales against forecast sales on a graph is a useful way to monitor the achievement of this target.

Similarly, a firm may set a target to increase annual profits by 10% over the previous year. If, at the end of the first quarter, profits are down, it can take action either to boost revenues or cut costs, for example buying materials from a cheaper source of supply.

Using accounting information to assist managers in planning, decision-making, and guiding a business is known as management accounting.


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