The Importance of Understanding and Using Management Accounts

Transcription

1 MANAGEMENT ACCOUNTS GOOD PRACTICE GUIDE FOR FURTHER EDUCATION COLLEGES Contents Page 1. Introduction 2 2. General principles 3 3. Accounting concepts and policies 4 4. Income recognition 5 5. Expenditure 6 6. Capital expenditure 7 7. Forecasts 7 8. Cash flow 8 9. Departmental analyses, activity based costing and overheads August management accounts Non-financial information Key performance indicators Budgets The commentary Using the management accounts Conclusions 12

2 MANAGEMENT ACCOUNTS GOOD PRACTICE GUIDE 1. Introduction Throughout the academic year a College Corporation and its Senior Management Team will be looking to take stock of progress towards achieving operational and strategic objectives. To do this, Governors, committee members and managers need to receive regular data on the performance of the college. Typically, this will include information about recruitment, retention and achievement of learners, analysis about the progress towards operational and funding targets, as well as risk management and financial reports. Management accounts are a powerful source of management information which brings together data about actual performance to date ( Year to Date ) and projections for the full year ( Forecast ). The impact of curriculum issues for example recruitment, retention and achievement, will impact on the viability of courses and the generation of income and the level of expenditure at a business area or directorate level and may, where significant, impact on the overall performance of the college. Management accounts have two fundamental aims: To support and inform the budgetary control processes within a college. To provide projections about the likely outturn financial position of the college for the full year. Whilst the format for presenting management accounts can vary between colleges, the above two aims must be met. By reporting performance against the budget, the SMT is demonstrating its control of the financial drivers of the business; and, by comparing actual income and expenditure against the planned budgets provides valuable information, which will support the effective review of the projections for the rest of the year. This process informs risk management and decision making. Research confirms the requirement for a college s management accounts to be drafted with the nonaccountant in mind, both for the Senior Management Team and governors. This has two consequences. Firstly, the information should explain matters in clear non-technical terms; and, secondly these narrative explanations should provide links to the supporting data tables in a clear and transparent way. The source of all the financial information within the commentary should be readily identified within the supporting financial tables and the reader should be encouraged to follow information through to the tables. It is important for the Finance Director to regularly discuss with colleagues and governors the format and content of the management accounts, particularly to secure the right balance between summary and detail. Research confirms that most colleges produce the same management accounts for the Senior Management Team and the governors. It is quite legitimate however for a college to produce more detailed information and analysis for senior managers and budget holders to support their operational requirements and supply this in a more summarised form to governors. In governance terms, the important factor is that the information provided to senior managers and governors must be consistent, and all governors are advised of, and have access to, operational information where they seek it and where it is relevant to issues impacting on overall performance. It would be wrong to assume that all FE colleges are the same, so there is not a one size fits all solution for college management accounts. It is for senior managers and governors, as regular users of management accounts, to decide what works for them. However, the following guidelines and the accompanying model are intended to provide some ideas of how college management accounts production and presentation could be improved to provide a more useful leadership tool. For the purposes of these guidelines, management accounts and accompanying reports that are presented to senior management, governors and third parties periodically during the financial year should have the objective of enabling them to assess, as a minimum: The surplus or deficit for the period, the financial year to date and the forecast for the end of the financial year 2

3 An understanding of how the surpluses or deficits have been arrived at, how and why they vary from budgets and what may need to be done to bring the college back on plan The financial position of the college at the period end and as expected at the financial year end, and whether its control of assets and liabilities, solvency and financial stability is satisfactory The cash flow for the period, financial year to date, forecast for the remainder of the financial year and at least the next 12 months. The above are a minimum. Colleges are encouraged to include such additional information in management accounts as may be considered relevant to the users of their management accounts. 2. General principles Keep it simple this will aid preparation and understanding and will help to reduce the time taken for users to receive the accounts so they can take timely decisions. The average time taken to publish management accounts in the sector is currently 10 days. Automating processes as much as possible can reduce the time taken and avoid manual errors. Variance and ratio analysis should be incorporated in management accounts appropriately, with explanation for significant variances. However, the calculation of variances for every item in the accounts may be counter-productive. It is suggested that, for the majority of colleges, significant variances from budget for income statement items should suffice. Whilst some colleges report a comparison with prior year performance, the rapid rate of change in the FE sector can make such historic comparison unhelpful. Ratios that are used in financial health scoring should be included so readers gain an appreciation of the relevance of these measures. Whilst most colleges prepare management accounts monthly, it may be that for smaller sixth form colleges with relatively little other activity, longer management accounting periods (e.g. half-termly) may suffice. However, mid month cut-offs can cause significant additional work and monthly closure of the accounts soon becomes an efficient routine through regular application and can lead to more streamlined year end accounts production. 3. Accounting concepts and policies The fundamental accounting concepts of matching, prudence, accruals and consistency should be applied to management accounts, so far as practical. The accounting policies used for the college s annual financial statements should be used for management accounts as far as possible and applicable. Readers are then better able to understand the basis of preparation of the management accounts. However, this is not intended to imply that the format of the management accounts should follow those of the annual financial statements. If different accounting policies have to be adopted then these should be made clear to readers of the management accounts. It is suggested that, unless users of management accounts particularly need interim information on FRS17, these pension adjustments should be excluded from management accounts since colleges generally have minimal influence over the FRS17 adjustments and such data tends to be available only for annual financial statements. Colleges may decide to include the last reported pension liability in the balance sheet, in which case net assets and reserves should be shown both before and after FRS17 adjustment. A proposed general principle for the production of interim accounts is that they should reflect the journey through the year towards the year-end result. The foundation for this principle derives from the fact that the vast majority of most colleges activities operate on an annual cycle and there is much more focus on year end achievements, both for financial and operational key performance indicators. If this principle is followed then it may be inappropriate to produce management accounts that show wild swings in interim surpluses or deficits or key ratios, unless this is truly what is happening in the operations of the institution. It is suggested that the relevant principles in the Accounting Standards Board s Statement on Half- Yearly Financial Reports (issued 2007) should be adopted. In particular, the Statement recommends 3

4 the discrete method for recognising income and expense, but depending on the nature of particular items of income or expense, the integral method may also be applicable. In practice, for colleges, this means that reported income and expenditure for a particular period should generally reflect the activities of that period. Approaches to achieving this are set out in the sections below. Another principle that could be adopted for the presentation of management accounts would be to regard certain college activities as having similar characteristics to long term contracts, albeit not usually extending beyond the current financial year. Under relevant accounting standards the accounting for long term contracts would require (a) surpluses only to be recognised when the outcome can be foreseen with reasonable certainty and then in proportion to the appropriate extent of completion, and (b) deficits to be accounted for immediately they are anticipated. An example that demonstrates the above principles shown graphically below: YEAR TO DATE OPERATING SURPLUS Actual Budget 0-50 Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Income recognition SFA/EFA recurrent grant for FE activity is received by colleges in accordance with a monthly payment profile that varies between 5.16% and 12.56%. Given this variation in monthly receipts it is suggested that the FE funding allocation should be more evenly spread throughout the year for management accounting purposes. It will be for each college to decide how to flex this spread, having regard to available information such as student recruitments, ILR data, retention reports, exam results etc. For institutions that have significant student enrolments later in the financial year it will be advisable to weight the monthly recurrent grant so that it reflects student activity levels. Similar principles to the above may also be applied to HE activity. Demand led income streams such as Apprenticeships and Responsive funding are in some ways less problematic as income is received in accordance with learner activity. However, care needs to be taken to match income with expenditure if there are significant fluctuations in activity levels. Also, regular checks need to be undertaken as part of the management accounts preparation process to ensure that income recognition is in line with learner recruitments and completions. Tuition fees, fees for full cost activity and education contract income should be spread over the relevant periods of expected activity, in accordance with the 2007 SORP. This can be an issue for colleges with programmes of varying length, or significant employer engagement initiatives where sales teams may expect credit to be recognised in the management accounts at the time the sale is secured. In the case of education contract income it should be the period in which costs are expended that determines when income will be recognised. Preparers of management accounts may need to adopt appropriate estimation techniques and will need to carefully consider the prudence of recognising any income that has not yet been paid. 4

5 Whatever basis for income recognition is adopted needs to be clearly explained to users of management accounts and consistently applied. 5. Expenditure Pay costs will generally be accounted for in accordance with the payroll period. Exceptions may arise in the form of holiday pay accruals (if significant) and for holiday periods when either hourly paid staff have not been working or when timesheets may have missed payroll deadlines. It would be appropriate to make accrual for these pay costs, if significant. Colleges operating bonus schemes should follow the interim reporting principles, i.e. to accrue prorata in management accounts if there is a contractual or performance-related entitlement, but with no accrual for discretionary bonuses. In accounting for non-pay expenditure it is common practice within the sector to accrue costs based on purchase orders. This provides a more prudent approach but, if significant orders distort the results for the month then it may be appropriate to reverse all or part of the cost if the goods have not been delivered (or included in stock) or services have not been performed. This situation may arise with blanket orders (e.g. for supplies to be delivered over a period of several months). Similarly, significant costs such as premises rents, insurances, annual maintenance contracts and annual licences may need to be prepaid. On the other hand, it is important to review certain individual accounts for significant missing accruals at the period end (e.g. utilities, service charges). For significant expense areas where there are inevitable timing differences between supplier payment and the cost being incurred (e.g. examinations costs or bus contract costs) it is recommended that the estimated cost is spread over the period of study, but with regular revisions of the total estimated cost having regard to actual costs paid and other available data (e.g. student numbers). Colleges with their own catering and retail operations and franchising are recommended to check whether the margins for the accounting period for these activities are in line with expectation. Significant differences may be due to cut-off issues that need to be adjusted for prior to publishing the management accounts. 6. Capital expenditure For major capital projects it may be more relevant to recognise expenditure based on valuation certificates, particularly if the valuation takes place before the period end but it is likely that the contractor will not submit the invoice or application for payment until after the period end, when the accounts have been closed. This approach also ensures that retentions are accrued. Given the magnitude and complexity of some capital projects within the sector, separate project progress reports may accompany the management accounts, dealing with costs, variations, claims, percentage completion by stage and timescales against plans. 7. Forecasts Following the above principle that the management accounts are part of a journey through the financial year to the year-end, year-end forecasts are likely to be just as significant as the period end figures. Regular re-forecasts are therefore an important part of management accounts procedures, particularly following significant milestones during the academic year (e.g. first ILR, main enrolment dates, contract reviews). The production of each set of management accounts is a good opportunity to review forecasts. Relevant budget holders should be engaged in any discussion about forecasting (a) because they should have a closer view of the likely full year outcome and (b) to ensure that they have ownership of the forecast. 5

6 Forecasts should not over-write budgets (as approved by governors before the start of the year) and should not be referred to as revised budgets. Reference may be needed to college Financial Regulations if these include provisions for forecasts that exceed approved budgets. In re-forecasting, use should be made of extrapolation calculations for income and cost lines from year to date figures. In addition, checks of the reasonableness of ratios such as income per learner and pay cost per FTE staff member will assist in re-forecasting. The process of regular re-forecasting and review is potentially a powerful tool. Looking ahead and integrating financial outcomes with performance metrics, accompanied by analysis of underlying performance and trends enables colleges to redirect resources, seize opportunities and avoid pitfalls on a timely basis. 8. Cash flow Cash flow forecasting is the perhaps the most difficult but most essential part of the management accounts as, without anticipated overdraft facilities and corrective action to reverse declining cash, the college will be in financial difficulty. It is already accepted as good practice in the sector to look ahead for at least 12 months from the date of the management accounts, however difficult that might be, given the uncertainties of the next financial year! It is therefore important that the cash flow forecast is reviewed and updated every time management accounts are prepared. Often, there will be differences between one month and the next but the third month onwards can still be a valid forecast. The most important aspect is probably explaining differences between actual and forecast (and maybe also budget) in the narrative so the reader can appreciate the extent of timing differences or and how much may be an emerging trend. For most colleges that are unlikely to be in financial difficulty, it is recommended that the cash flow forecast is presented as a chart, in monthly steps, rather than as up to 24 columns of mind-numbing figures in either receipts and payments statements or (even less meaningful) sources and applications of funds. Such blocks of numerical data, some of which will be uncertain anyway, are generally likely to turn off even the most financially qualified reader. Whilst it might be nice to remind users of how much the wage bill is each month and its impact on the bank balance, repeating this information over several accounting periods diminishes its impact. Preparers should bear in mind that what really matters in such forecasts is whether the college will either run out of money or will have surplus funds to invest in future projects. An example chart is shown below: m Cash actual Cash forecast Borrowing actual Borrowing forecast Jul 07 Oct Jan 08 Apr Jul 08 Month Oct Jan 09 Apr Jul Departmental analyses, activity based costing and overheads If accounting systems, cost allocations, recharging routines and general ledger coding structures allow appropriate analyses into departments, profit or cost centres or operating units then those colleges will 6

7 be better informed of the relative profitability or cost-effectiveness of those activities. However, presentation of such information in management accounts needs to be approached with caution for the following reasons: 1. In larger colleges, with over 100 profit or cost centres then presentation of departmental results could run to many pages, particularly if period, year to date and full year data is presented, with comparisons against budget. Whilst it will be totally appropriate and highly recommended to provide such information to budget holders, this may be too much detail and too much information for senior managers collectively and governors. One approach may be to consolidate the profit or cost centres into relevant groupings. However, this tends to lose sight of underlying issues. Another approach could be to only report on those profit or cost centres that may be a cause for concern, or to focus in a particular period only on some profit or cost centre, although these approaches go against the principle of consistency in management accounts reporting. If a particular area of activity is being reviewed in detail, this may be better dealt with as a separate report outside of the management accounts. 2. Departmental accounting, to be fully meaningful, requires the allocation of overheads. A favoured approach for such allocation is through the application of activity based costing. The dangers with this, apart from the preparation time, are that the additional information can result in time being wasted in divisive arguments about who should pay for what overheads. This is something that is much better resolved at the time when budgets for the year are set. A suggested approach for most colleges is to refer in the commentary to the management accounts to relevant profit or cost centre results if they are so significant that they are impacting on an income or expenditure item in the management accounts which itself requires explanation. 10. August management accounts Concern has been expressed by some Finance Directors about preparing management accounts for the month of August for colleges that only begin their main student enrolment in late August with little teaching activity in that month. It is recommended that, if monthly accounting routines are followed, the accounts for the month should be adjusted by budgeting income recognised to achieve a breakeven result for the relevant activity. However, if it is believed that surpluses have been realised on other activities or it is expected that losses have been incurred then these surpluses and / or deficits should be booked. A further recommendation would be to prepare but not to publish management accounts for the month of August (a) because of the nature of teaching activity in that month which may make the management accounts meaningless, (b) because senior managers and governors may be more occupied with student recruitments and (c) finance staff are still dealing with auditors and year end financial statements. 11. Non-financial information It is not essential that non-financial information is included in the management accounts if this information is presented by others through alternative reports. However, it is important that preparers of management accounts proactively seek out such non-financial information to confirm the validity of the management accounts or cover these areas if they are not dealt with elsewhere. Inclusion of nonfinancial information also helps to explain analyses of variances between volume, mix and price. If such information is included in management accounts then the preparer needs to be satisfied that the data is sufficiently reliable so as not to damage the integrity of the management accounts. Suggested key areas are: Learner numbers (or FTEs or SLNs), subdivided into age groups, funding streams and possibly even learning groups if there are significant differences in funding per learner. The ILR Learner Numbers with Funding report is a useful tool for FE learner data. 7

8 Staff numbers (or FTEs) ideally analysed into a manageable number of appropriate sub-groups and, as a minimum, split between teaching and non-teaching and full-time or hourly paid. Additional information about teaching staff deployment or remission time may also be helpful. Risks register or risk management plan (if not reported elsewhere). 12. Key performance indicators The management accounts are an opportunity for the college s finance leader to demonstrate progress towards financial goals that have been set by governors. Whilst such information may sometimes be reported in separate reports, it is suggested that preparers of management accounts may wish to consider whether the time taken to prepare such reports could be saved if the information is automatically produced in management accounts. The following may be KPIs applicable: Surplus as a percentage of income Pay cost as a percentage of income Debtor days, and/ or sales ledger ageing or bad and doubtful debts schedules Cash days Creditor days, and / or payment performance data Current ratio Gearing Treasury performance interest receipt and payment rates Compliance with bank covenants, if applicable, particularly if management accounts are sent to bankers Financial health rating Efficiency measures Benchmarking measures Some of the above may lend themselves to presentation in simple charts or graphs or as a traffic light or balanced scorecard system, particularly if trends are being tracked, to avoid the risk of readers passing swiftly over columns of boring figures that they do not fully comprehend or regard as not directly relevant to their immediate area of responsibility or interest. 13. Budgets Whilst it is beyond the scope of these guidelines to explore how colleges prepare their annual or calendarised budgets, the accuracy of the budgets for each month will have a direct bearing on the variances from budgets that will be reported in management accounts. Budget holders should be engaged with the finance team in decisions about the phasing of their budget over the year, both to ensure understanding of the assumptions being made and to gain ownership of the calendarised budgets. 14. The commentary A recent survey found that, on average, 11% of Governors were financially qualified. Given this level of financial ability in most governing bodies and Senior Management Teams, the commentary with the management accounts should assume limited financial knowledge. Terminology and abbreviations (both financial and college-related) should be either avoided or fully explained. It may be appropriate for the commentary to begin with a short executive summary of the key points, particularly if it runs to more than a couple of pages. The commentary should highlight the important data in the accounts and clarify important issues or emerging risks that the figures or trends may raise. As general guidance, although this may vary according to the institution, judgement or opinion in the commentary should be used by the author only when supported by evidence in the management accounts. Such comment should be constructive wherever possible, i.e. not reporting problems without also outlining solutions. Unless something is patently obvious to the preparer of the 8

9 management accounts or within the remit of Financial Regulations (e.g. to identify a budget holder who is likely to exceed the approved budget limit) then it should be for users to draw their own conclusions and recommendations for any strategic actions required. It is worth remembering that the commentary is more likely to be read and understood than any pages of supporting financial data. It is therefore important to get the messages across in this narrative. 15. Using the management accounts Management accounts should not be regarded as an end product. Rather, they are a tool to assist managers and governors in taking decisions to better manage the finances of their college. Significant variances should be clearly identified and explained, so management account users can understand whether these arise from volume, mix, price changes, or timing differences, thereby better enabling appropriate corrective decisions to be taken. Providing information about the extent of dependence on certain income streams, with the relative profitability of individual activities, presented in absolute and percentage margin terms, will help to develop strategies for improving profitability. This may also point to decisions to discontinue lossmaking activities or improve control and operating efficiency in certain areas. The above can apply equally to staffing costs analyses, where it may be helpful to consider the ratio of full-time to part-time staff, or compare the costs per FTE for different departments, or compare teaching staff deployment levels. Comparison may be against budgets or external benchmarks. These will aid decision-making about personnel strategies. Staff performance indicators may need to be further developed where colleges adopt more innovative pay schemes, linked for example to caseloading or success rates. Ratio analysis can be applied to numerous areas of the accounts. However, as a minimum, those relating to solvency and financial health may be the most useful for managers and governors to become familiar with. This should help them to consider, for example, the affordability and timing of major projects and to foresee any cash crises. Inclusion in the management accounts of some sensitivity analysis to show the consequences of a possible change in key income or spend areas may help to warn decision-makers of the possible impact on solvency and financial health indicators of identified risks and should inform the college s risk management process. Forecasts in management accounts must be credible, having regard to year-to-date income and costs. If reported forecasts do not approximate to extrapolations of these year-to-date figures then users of the management accounts need to understand what will happen over the remainder of the year that will be different and whether these explanations are realistic. Managers and governors need to be helped to carry out these basic extrapolation and reasonableness tests to increase their confidence in using management accounts as a robust decision-making tool. 16. Conclusions The aim of these guidelines and recommendations is to help improve the leadership of Governors, Senior Managers and Heads of Finance in the running and future development of their institutions. Whilst the importance of finance in some colleges may be played down as being too business-like for academics or does not fit with the ethos of doing the best for learners, without the financial resources to assure the college s future these sentiments become meaningless. Appropriate use of management accounts is the best available opportunity for Senior Management Teams and Governors to review current and anticipated financial performance and take corrective action during a financial year, and will inform plans and budgets for future years. 9

10 Amongst the potential benefits from these guidelines are better skilled managers who are engaged with planning what the future will look like. They can gain a deeper understanding of the risks, cost drivers, variables and contributions to overheads for their college. For the college s leaders the management accounts and forecasts can act as a tool for relating funds with outcomes and help to assess value for money. Relevant application of the above guidelines and the accompanying model management accounts should help to improve the quality and usability of management accounts for the FE sector. 10