Are You Sure About the Profitability of Your Business?
If you're not completely sure, read on to consider the benefits of engaging in a financial analysis consultation to identify your business's key performance measures.
By Paul R. Kramme, Kramme Consulting
Do you have questions about the profitability of your business?
General Ledger programs such as QuickBooks, Peachtree, and others provide multiple reports that reflect important information about a business's financial status. Two of the most important reports are the Balance Sheet and Income Statement.
The Balance Sheet reports a company's assets, liabilities, and stockholders' equity as of a specific date. The Income Statement reports Sales, Cost of Goods, Gross Profit, General Operating Expenses, and Misc. Income & Expenses covering a specific date range.
The focus in this article is based on the Income Statement. When viewing an Income Statement it is possible that what is being looked at may not be clear or fully understood. Additionally, an Income Statement does not provide in-depth insight into other important business performance measures.
A detail business financial analysis should examine several key business performance measures including:
- Sales and Cost of Goods Distributions and Related Margins
- Shop and Sales Productivity
- Overhead and Loaded Labor & Benefit Rates
- Sales Breakeven Point
- Net Profit
- And More
Sales and Cost of Goods Distributions and Related Margins
Depending on the pricing system being used it is likely that sales will be separated into multiple sales categories such as "In-House", "Outsourced", "Electrical", "Service", "Installation", and others. These categories may or may not be reflected the same way in a General Ledger program. Similarly, cost of goods may or may not be captured in the pricing system and reflecting a correlation with sales categories. It is also possible that cost of goods may be reflected only in the General Ledger program and may or may not correlate with the sales categories. For purposes of an analysis the ideal is to have sales and cost of goods that correlate with each other. This is important because gross profit (sales less cost of goods) is typically different for the different sales categories. Therefore, in a detailed analysis the objective is to be able to view sales, cost of goods, and gross profit for each sales category and total sales. A detailed analysis will also permit a business owner to learn whether the respective gross profit levels are "Ideal" for the sign industry as a whole.
Shop and Sales Productivity
Shop and sales productivity may not be directly evident when examining an Income Statement. However, a detailed analysis should identify full time equivalent (FTE) levels for "production", "sales", and "Owner/Administrative" staff. This type of measure can help an owner assess current staffing levels against current sales as well as projecting future staffing needs as sales increase or decrease. A detailed analysis should also identify the average sales produced per FTE, average production staff productivity produced per hour, and the average production productivity hours per day (YES, it will be less than a normal 8-hour day).
Overhead and Loaded Labor & Benefit Rates
The operating expenses reflected in an Income Statement can be separated into fixed costs and variable costs. Fixed costs consist of all costs that are generally constant and are not directly influenced by increases or decreases in sales levels. Variable costs, on the other hand, are influenced by increases or decreases in sales levels. A detailed analysis should express the fixed costs on a cost per hour basis to permit the inclusion of this cost either directly or indirectly into the pricing of products and services. Loaded labor & benefit rates include all costs for wages paid (including overtime) plus related payroll taxes and benefits costs. A detailed analysis should express the loaded labor & benefit costs on a per hour basis to permit the inclusion of these costs either directly or indirectly in the pricing of products and services.
Sales Breakeven Point
Fixed costs are typically thought of as the "cost to open the door" each day. Based on the fixed costs and current distribution of sales and cost of goods, a detailed analysis should establish the total sales required to cover the fixed costs (referred to as sales breakeven point) and total operating costs based on the current sales and cost of goods ratios.
Finally, an Income Statement will reflect the net profit of a business. Net profit is calculated as sales less cost of goods less operating expenses. A detailed analysis should reflect the same net profit as that shown in the Income Statement even if the analysis re-states some of the sales, cost of goods, and/or operating expenses.
One business owner and accountant may elect to treat wages paid and depreciation expenses as operating expenses or cost of goods. Some may elect to treat wages paid as a combination of operating expenses and cost of goods. Similarly, some may elect to treat depreciation as an operating expense or cost of goods. A detailed analysis should permit these types of choices.
There is not a simple "yes" or "no" answer to whether a financial consultation is needed. Consider the following to help decide if a financial consultation might be helpful:
- Are there concerns and / or doubts about profitability?
- Can't find, or don't understand what to know about profitability?
- Or, don't know what to know about profitability?
If you decide a financial consultation might be of value to you, you should expect to receive a detailed analysis including a narrative report identifying areas where improvement is warranted.
With over 50 years in the workplace Paul Kramme has utilized his mathematical and analytical education, background, and experiences in multiple businesses and industries including 10 years as a successful sign-industry owner. Paul has assisted hundreds of clients implement their pricing software, assisting them with pricing strategies, and guiding them in the use of general ledger accounting programs. Kramme Consulting offers independent Financial Consultation services to sign industry businesses. The services are independent of the General Ledger and Pricing Software used by a business. - www.pkrammeconsulting.com