Unstructured Accounting and Business Management

Contents

1. Introduction
2. Structured and Unstructured accounting
3. Business Structure in the Third World
4. Insight into smaller businesses.
5. Unstructured Business Management.
6. Budgetary controls
7. Implications
8. Growing the Business.
9. Financial Statements.
10. Lessons from the unstructured business and accounting
11. Opportunities for Structured Operations.
12. Signals Chief Executives. must not Ignore
13. Suggestions.

Introduction

Larger companies are mandated by law to include audited financial statements along with their reports to their shareholders at least once every year.
Most smaller businesses however, do not see the need for this “ritual” as they are owned either by an individual or a family, especially when they are not incorporated as a limited liability company under the various laws in their countries.
These which form the largest business activity in most countries of the world, is of special interest in third world economies which can be described as is one where many useful products and services are in short supply.

What is available in abundance is largely limited to what individual efforts and skills produce.
Something very certain is that a loss making business will one day grind to a halt, once the resources sustaining it are depleted. It will then fail to provide the expected regular income to its operators, and may find it difficult to settle its creditors. A business is deemed to be successful when it settles its creditors as, and when due, and provides sustainable income to its operators over a long period of time.

Structured and Unstructured Accounting

This, obviously will be referred as the “structured accounting”.

The industrial revolution made the need for structured accounting apparent. In many third world countries where an equivalent of the industrial revolution has not yet taken place may therefore not see the need as their operations are usually simple.
How do they know if their businesses make a profit when we take into account their limited formal education and knowledge of accounting?

I believe the answers may give important lessons in business management.

Business Structure in the Third World

The challenges now faced is what happens when the business grows beyond what can operate in only one location or be physically supervised alone, especially when the operations become more complex.
This may not be a big challenge in a modern economy, as many tools are available, such as:-

1. Point of sale terminals which read bar codes, and instantly invoices the customer, updates the inventory levels when such systems are so arranged.
2. Closed Circuit Television Cameras (CCTV) would make many sections of a store available to a security team or record events in shops for playback whenever the need arises.
3. Use of credit cards which only credit the entrepreneur's account when sales are made with it.
4. Alarms which go off when some unpaid items leave the store.

Expansion is reduced as the only operation delegated is when an apprentice or assistant is hired to stay in the shop when the trader is physically absent, who takes a physical stock of items on display and expects the cash earned during the usually brief periods of absence to tally with the estimated selling prices.
Sometimes, trusted family members are engaged.
This practice is usually carried on by many, into old age.

The result is that products and services provided by group or organizational efforts or those that require complex operations are not in abundance in most third world countries.
Most local businesses are small with few employees, and carry out relatively simple operations, which has resulted in the scarcity of bigger and more organized establishments.
You will therefore have queues in banks, department stores, hospitals and even admission into good schools, and of course, queues in employment openings.
This is not to say that every big businesses in Nigeria for example, will have queues of customers.
However, most well managed ones often attract long costumer queues.

Insight into smaller businesses.

Some traders are able to do a very good job mentally monitoring their businesses.
The more educated ones keep notes and records in notebooks or jotters from which a structured accounting system can then be prepared.
As a result of self discipline and pragmatic actions over the years, those able to keep their businesses running without incurring serious debts come up with testimonies such as:

1. I built those houses through this business
2. I paid all the expenses on education for all the children from this business,
3. We regularly went on vacations solely on the profits of the business.

Unstructured Business Management.

1. Locking up the shop when absent. This has implications for vacation time or times of compulsory or urgent travel.
2. May have to invite a “brother” or “sister” to oversee the business during times of extended absence, and may have to suspend vital transactions, or even close the business until his/her return.
3. Expect only the goods left in inventory to be sold during absence. The inventory is checked and the receipts are collected, without any consideration on whether they were sold at the correct prices, or customers' preferences.
4. Staff and employees will have to loiter around during breaks, until the Boss returns to open the shop (may also mean warehouse or a cottage factory).
5. Personally authorize all transactions as the sole signatory and only one with access to the bank accounts and information.

Some of the more laudable practices however are as follows:

1. Cash meant for purchasing of goods is always separated before any other expense is made.
2. Regular mental exercises as to where the cash is as the inventory level falls.
   Example is : “A certain amount is in the bank, while another amount has not yet been paid by debtors. while another has been used to deposit for more goods.”
3. Ensuring that the product sells itself.“By the time the inventory level reaches a certain level, the money made must be able to buy that original quantity.”
4. Goods purchased with a loan, or on credit are usually mentally segmented in inventory until the cash realized settles the credit or loan.

Budgetary controls

For simple operations, selling prices are easier to determine: the cost of purchase with an additional margin to cover associated expenses, or the selling price of the competitor, whichever is higher.
Some just try to recover the associated expenses, like transport, on the first few items, while disposing off the rest at a little mark up.

One is made to believe this as a safe and fool proof way of doing business. There are however several drawbacks:

1. Inability to estimate goodwill equitably in the event of a proposed sale or invitation of a partner, or in making feasibility studies when attracting larger or strategic investors.
2. Difficulty in making proposals for credit facilities. Creditors may not be able to appreciate the operations without guidance from formal accounting statements.
3. Limitations of the human memory in eliminating errors, even when jotted down, which itself is the main advantage of the double entry bookkeeping principle.
4. Memory limitations on current assets levels.
5. Inability to correctly place all classes of assets mentally.
6. Limitations as a result of inability to be physically present at all times.
7. Proprietor is preoccupied with routines, and less time is available for improvements and innovations.
8. Business is limited to a few items. This unstructured model may not cope efficiently with thousands of items from thousands of suppliers.
   A common practice, particularly among Pharmaceutical shops is to classify the thousands of different items into a much smaller number of groups that can then be managed mentally. Optimizing the mix can be challenging however, without a structured management report.

The Implications of the practices

1. Cash meant for purchasing goods
   is always separated before any other expense is paid. This ensures enough cash available to continue the business. However, the profit made is never equal to the cash surplus. Cash payments for assets, for example, should not be part of expenses.
   Structured accounting ensures regular write downs on assets over their useful lives. It is only logical to reason that furniture, equipment and machinery used in a business will not always be like new as the years roll by.
   Only the amount set aside as depreciation is expensed in a particular accounting period. In this instance, the profits should be more than the cash surplus. The proprietor will therefore not be equitably rewarded if the business is sold on the basis of cash surpluses.
   This practice however may not be possible in bigger businesses as a lower staff morale can damage the business, if payment of salaries is delayed.
2. Regular mental exercise as to where the cash is as the inventory level falls.
   This implies that the inventory is monitored regularly, a practice which is similar to regular stock taking practice during audits. Registered incorporated companies are required by law to submit audited accounts annually to the authorities.
3. Ensuring that the product sells itself.
   This is a business decision as it ensures that only profitable items are in the inventory. This in itself implies that the proprietor is able to identify and promote the profitable products, which must be a process which takes time and considerable analysis.
   Quite often, personal efforts made in procuring the goods are not adequately quantified in procurement costs.
4. Goods purchased with a loan, or on credit will be mentally segmented in inventory until the cash realized settles the credit or loan. This forms a practical approach at controlling debts. Any amount owed to outsiders and the movement of cash normally shows up in the balance sheet and the cash flow statements.

Growing the business.

This is known as the institution of internal controls.

• Records are expected to be generated by these processes.
• An accountant will not have to waste considerable time to piece together disjointed information to produce financial statements.
• Proprietors will not have to close shop, or temporarily engage a “brother or sister” to oversee the business during a period of prolonged absence. The extent of this structure varies with the complexity of the operations of the business.

A good example can be observed in a wholesale shop where the customer pays for items in a section of the shop, and a receipted invoice or waybill is issued for the items to be collected in another section.
This simple arrangement ensures the following:-

1. No unauthorized person collects money from the customer.
2. Every item collected by the customer is documented and paid for.
3. There are two verifiable records for goods sold, one from the receipted invoicing section, and the other from the collection section. This can simplify the process of error and fraud detection.
4. The process of collating figures for accounting statements by the accountant, or for an accounting system is easier.

In an age of cheap information systems, these processes can be integrated in an online system, whereby price verification, inventory level reporting, sales figures and other important information can be supplied and analyzed instantly with the use of bar code readers and various point of sales terminal equipment.

Payments for cash items can be made through an imprest account which should be retired and accounted for by a responsible official. Other major payments are to be made with checks. The process of collating payments in publishing the structured accounting statement is then simplified.

We may now cap up the whole processes with the engagement of an internal auditor, (who may be contracted, or employed) to check and verify the records generated with physical evidences, especially when payments are about to be made.

The business can then be carried on even in the proprietor's absence.

The publication of these information in a compressed form gives the proprietor an overall view of the performance of the business, and some other opportunities that business intelligence and data mining tools will reveal with the structured accounting statements.

With these, it can be seen that managing a business, with many branches or complex operations may not be as difficult is it usually turns out to be.

Managers should however, not get carried away or be mentally disconnected from the mental budgets, which, from time to time should be adjusted regularly as the need arises.
Information technology products earlier mentioned (credit cards, point of sales terminals, CCTV etc) also assist in the enforcement of internal controls where electricity is available.
However, as credit cards are not widely used in most African countries, for example, businesses have to deal with cash payments. The internal control will also therefore, have to deal with the process of banking the sales into the designated accounts.

Financial Statements.

• The trading account.
  This consists of stock carried into the opening period at lower of cost or net realizable value. This is added to the total value of items purchased during the period. The closing stock value at the end of the period is then deducted from this total to give the “cost of goods sold”.
  When this figure is deducted from the sales for the period, result indicates the actual value of gross profit attributed to the sold items for the period. The unsold items are regarded as assets and the profit that will be made is not computed until the actual sales take place in the following period.
• Profit and loss account.
  The administrative expenses for the period, with the addition of “depreciation” is deducted from the gross profit to give the net profit for the year before taxation.
  The surplus is accumulated into a profit and loss appropriation account, from which amounts deemed necessary may either be shared by the proprietor(s) or transferred to a reserve, which may be used for various purposes.
  The balance on this account is carried forward to the following period.
• The Balance sheet.
  As the amounts expended on assets are not deducted when computing profits, they are recorded as assets. These also include prepayments for goods not yet received. Similarly, items received for which payments have not been made as well as loans are also recorded as liabilities. There are also several classes of these, which depend on their permanence. Those expected to be settled within the following year are generally regarded as current (liabilities or assets).
  The difference between them should equal the accumulated profits and reserves.
• Statements of Source and application of funds (Cash Flow Statement). Most unstructured business people relate more to this statement and
• Statements of value added.

With these, one can see how the structured account gives the information the unstructured manager needs, while, in addition, supplying frequently overlooked details such as management salaries and depreciation in the operating statement.

Lessons from the unstructured business and accounting.

This mental picture can only be established as a result of an in depth study of the budget. The chief executive should occasionally ask the accountant to revise the projected results in the light of some developments, or should have a spreadsheet model available.
When dealing with several items from several suppliers, items should be classified into groups just as the unstructured business people do. This makes the data easier to manage and understand.

Business opportunities for structured operations

Signals Chief executives must not ignore

This can be illustrated with the following example:-
let us think of a customer, who buys items worth $10,000 monthly on credit from the business after due negotiation.
By the time the next month's purchase is made, the previous $10,000 should have been paid up. The cash income from that customer therefore will be $10,000 while goods for the same amount is collected.
At the end of the quarter, sales will be $30,000 while account receivable should still be $10,000.
If a budget for half a year is produced, the figures should be $60,000 and $10,000 respectively, while that of the year should be $120,000 and the same $10,000.
A quarterly budget therefore should not necessarily indicate thrice the monthly budget for all items.
This, however will not be the same with the cost of goods sold, which should vary somewhat with the
sales. Some others, such as energy costs, usually will have a fixed component as well as that which varies with energy use.
Structured accounting is simply the recording convention adopted to satisfy the reporting needs of businesses as observed through the centuries.

Suggestions:

1. Chief executives must to sketch out annual budgets themselves, and compare with what the Chief Information Officer (CIO), or Finance Director (FD) presents, to see how familiar they are with the business. It does not have to be as fancy but will be very useful. This is how unstructured business people cope with their businesses.
2. Must be able to segment mentally, trading made with borrowed funds, and must avoid using such funds to subsidize or prop up bad businesses.
3. The fastest way a new chief executive can get familiar with the operations of any organization is to go through the budgets of each department, and then compare the actual results for variance analysis.
4. Must set benchmarks for every level of operation in terms of cash flow.

With these, business management has very powerful tools to cope with today's challenges, especially when some of the pragmatic practices of the ancient times are not ignored.