By Dick Glass, CET
Profit-and-loss statements are valuable for more than helping compute the income tax. Use them as a management tool to spot unprofitable areas of your operation.
What's The Score?
Can you imagine a football game between Notre Dame and Texas, with no one totaling the score? The players continue to run, pass, block, punt, and make touchdowns in brilliant displays of power and skill, while the fans cheer wildly for each successful play of their team.
However, many mistakes are made, because there's no score board or time clock. A coach might take unneccessary risks, not knowing his team is safely ahead. Or, he omits a play that could bring a fast touchdown (but would not be good long-term strategy), because he doesn't know his team is behind and the clock is running out.
After a time, the enthusiasm of both fans and players begins to falter. Much of the excitement is gone when neither team wins.
The moral is obvious: games of sport must have scoreboards and time clocks. Your business, too, needs (for proper planning and good morale) a scoreboard called a "profit-and-loss" statement, covering a definite period of time. It's not enough to "play the game hard" by repairing all the machines you possibly can. You must know if you're winning or losing the economic "game." A few dollars in your pocket after you have paid all of the bills doesn't prove your business is profitable. Instead, you must com pare total income with total expenses.
-------Figure 1. Although very short, this is a complete P&L. It
shows total income, total expenses, and net profit.
-------Figure 2. Income from all basic sources should be listed, along with the associated expenses, and the items of overhead should be given separately. Showing gross profit from each source of income allows you to judge the relative profitability. What's more, you can spot trends by comparing the gross profits of successive P&Ls.
P&Ls Are Easy To Understand
If studying your profit-and-loss (P&L) statements required two or three hours of your time each week, or if you were forced to do complex mathematical computations, per haps you would be justified for giving the work to your accountant.
Fortunately, that isn't the case.
P&L statements are easy to under stand. After you become skilled at interpretation, you probably will spend only minutes a month in checking your "score." Many shop owners feel uncomfortable with a P&L because they don't understand all the advantages and uses. Perhaps only one is supplied to them per year. Often it's used solely as a step in the calculation of taxes. Unfortunately, this neglects some valuable applications of P&Ls.
Instead, a P&L statement should be prepared each month (each week for large operations), and used first as a management tool to monitor your business constantly.
What Can I Learn from a P&L
A P&L statement shows you these three basic things:
The amount of money you received (total sales).
The amount of money you spent (total expenses).
How much money you have left (total profit).
Figure 1 shows a condensed profit-and-loss statement. Although it might appear to be too simple, it is complete. It probably doesn't provide as much information as you need, but it's far better than evaluating your profit or loss by the thickness of your wallet.
Balance sheets At this point, perhaps you're wondering about balance sheets, and whether or not they accomplish essentially the same things as do P&Ls. Balance sheets show what you owe and what you own at the end of an accounting period. They are important in their own right, and we will explain them thoroughly next month. For now, it's enough to know that balance sheets and P&Ls work together.
Expanding the P&L
In addition to the three items mentioned above, other helpful information which can be obtained from P&Ls includes:
1. A comparison of your present statistics with last month or last year, to prove whether you are doing better or worse.
2. You can compare your expenses with industry averages, to determine if improvements are needed in any certain areas.
3. Your gross profit can be shown (gross profit is found by subtracting "direct labor" and "direct parts costs" from income).
4. Overhead expenses can be listed individually, and totaled, thus helping you to determine efficiency.
5. It can show the actual costs, allowing you to bill labor and parts charges more accurately.
Tips for P&Ls
Even if you have a one-man operation, you should have a P&L statement each month and annually.
An inventory is not necessary for each monthly P&L. One inventory per year should be sufficient.
Small business should not handle "parts inventory" and "owner's wages" by the conventional method.
Later, we'll tell you why and how.
The P&L is not an end in itself, but is merely one tool to help you answer your financial questions.
Gross profit
The term "gross profit" probably is a leading cause of confusion about P&L statements.
Perhaps gross profit would be more understandable if we thought of it as being an "intermediate frequency" of accounting. Although it's important, gross profit is not the .final figure we're after.
Gross profit is the "paper" profit remaining after you subtract from the total income all the direct or costs (such as wages for your techs, and the money paid for the components). Net profit is calculated by subtracting the overhead (general and administrative) expenses from the gross profit.
Figure 2 shows another P&L for Dick's TV, with figures for the gross profit included. This P&L contain; the same information as the less complicated one of Figure 1; however, it shows the individual items of expense and the computation of gross profit. Perhaps your yearly P&L appears to be much more extensive, yet it contains the same basic elements as the one of Figure 2.
Figure 3 Adding percentages to P&Ls allows you to compare those of different months without confusion.
Figure 4
The recommended P&L combines all o: the assent al data and the percentage figures of several P&Ls.
The greatest value of the Figure 2 P&L is that it shows how much you are spending on the three largest expense categories: wages; parts or components; and overhead.
Efficient operation demands that you keep these in balance for the type of store you have.
Notice that the direct wage cost is 50% of the total labor produced.
Usually, in this business, 50% wage costs is too high. The owner should increase the labor income or reduce the wage costs. The parts costs are 50% of the parts sales. This is about right for shops not doing much warranty work. Shops having a high rate of warranty repairs might only realize 20% to 30% of parts profits. Lastly, we see that the overhead expenses are 40% of total sales. Because the boss (who's not a technician) has included his own salary in the "clerical and administrative salaries" section of overhead expense, the 40% overhead figure probably is normal for this shop.
Percentages
While the Figure 2 P&L is quite informative, it lacks one thing: percentages. Otherwise, when you want to compare the figures for each month and year, you will be lost in a maze of figures. Using percentages provides a common denominator that makes comparisons easy and fast. Figure 3 is the same P&L, but with percentages added.
There is no limit on the time period of a P&L. It can be daily, weekly, monthly, quarterly, yearly, or whatever is needed.
Exceptions for Service Businesses
Two important differences in accounting methods are necessary for small service businesses: the method of handling parts costs and inventory; and the owner's salary.
Inventory I advise that a parts inventory be taken only once per year. Owners of small service shops ordinarily are so involved in the details of the business that they are aware of inventory changes at all times. Also, the proliferation of small parts makes an inventory a difficult and expensive task. Of course, a monthly inventory is desirable, but the benefits are less than the effort required. And the year-end inventory eventually will provide the adjustment.
Here is an example of a year-end parts inventory adjustment:
Parts inventory value 1-1-77 $6,000 Parts purchases 1-1-77 to 12-31-77 $60,000 Total $66,000 Less inventory 12-31-77 $16,000 Actual parts cost for 12 months $50,000 Owner's salary If the owner does no work of any kind (neither technical nor management), his salary must come from the net profits of the business.
Therefore, a non-working owner's salary should not be included in the single-proprietorship or partnership P&L. It is advisable to have a notation of the "Owner's Drawing Account" added at the bottom of the P&L to show the amount the owner has withdrawn during the accounting period. (Incidentally, a non-working owner will pay taxes only on the net profit shown by the year-end P&L, regardless of the amount he "draws.") However, if the owner performs technical or management functions, his salary properly belongs on the P&L under the correct expense category.
For example, if you as the owner spend 75% of your time working as a technician and the other 25% in managing the business, you should list 75% of your salary as "Direct Wage Cost," and the other 25% under the "Clerical And Administrative Salaries." Comparisons Now that gross profit and percentages have been included, one more step is needed: comparison of the latest P&L with the previous one.
Although there are many possible comparisons, the method I like is shown in Figure 4, which contains all the data listed before.
Analysis of the Figure 4 P&L can spot trends and identify any unusual changes before they become more dangerous. Notice that the net profit for the first six months is down by 19%. It's likely a problem is indicated, but the analysis to determine the source of the loss should be continued.
The overhead percentage is 39%, which is down slightly from last year, despite the big rent increase; and the gross labor profit is higher.
However, the gross parts profit dropped from 25% to 18%. Evidently, the lower parts sales (50% went down to 45%) and the rising parts costs (from 25% to 27%) combined to make the parts sales less profitable.
Also, notice the two percentages marked * and *4'. The first is the June percentage of labor costs to labor sales, which has decreased from 50% last year down to 42%.
The other is the June percentage of parts costs to parts sales, and it increased from last year's 50% up to 60%. Some shop owners are more concerned about those two percentages than about any others.
Certainly, they are very important.
Not all the percentages discussed were listed in Figure 4, but they were calculated from the figures given there.
In the example, both the total parts sales and the profitability of those sales are exposed as the problem that needs to be solved first.
The ability to pinpoint individual increases or decreases is the great value of the gross-profit listings, particularly when there are several entries.
Comments
Your P&Ls undoubtedly have other income categories (perhaps "merchandise sales," rentals, or others). Also, under General and Administrative I have shown only a few items instead of the long list most P&Ls have. Later in this series, we will return to Profit-And-Loss statements and explain how to split your P&L, separating the service and sales departments. Also, we will clear up that old nemesis called depreciation.
However, if you now are comfortable with P&Ls and understand how to use them, it's likely you won't have trouble with more complicated ones.
Use these suggestions about P&Ls to help make profitable decisions for your business operation.
(adapted from: Electronic Servicing magazine, Mar. 1978)
Next: Apr. 1978
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