I am going to base this discussion on the P & Ls of a company which makes folding metal chairs and tables. Their customer base is largely regional (hotels, schools and resorts) but they do some selling through national trade shows. The company has three chair lines: the Basic, the Bistro (a higher end line), custom commissions, plus a small line of tables. It’s a young company and sales are rising, but profits have plummeted.
The P & L sheet below shows three years of activity. For each number a percentage is shown to the right. That percent is derived by dividing the number to the left by Net Sales. This is extremely useful in analyzing the report. Loan payments and depreciation have been omitted.
If you look at the Revenue lines across the three years, you will note that Net Sales almost doubled between 2010 and 2012. However (and this is more common than you might think) they have gone from a profit of almost $76,000 to a loss of over $91,000 in the same period.
Look at the numbers below, evaluating them for information about the business. Items below in italics are the questions I would ask the client.
The fast rising sales suggests that the business is a solid: there is a market for the product and they are accessing that market. The basic line (which is much like other similar manufacturer’s product) is declining as a percentage of sales (53 to 36 percent) but still accounts for nearly half a million dollars in revenue. The bistro line has more than doubled in three years. (What is different about this line from others in the market? What do you know about why sales in this line are rising faster than the Basic line?)
Custom chair sales have almost tripled in dollar volume. (What is driving the sales?)
Break out your expense by product line where possible so you are able to determine which lines are most profitable and where to concentrate your efforts. For instance, if the custom line requires substantially more resources to build and sell than other lines, you need to evaluate how profitable it is at current prices). This was not possible for this company in previous years.
The Fixed Expense, although rising in dollar amounts, has declined as a percentage of sales. That’s good.
We can therefore deduce that the key issues are in the direct costs. Direct Costs are up 15.5% over previous year which resulted in $189,780 of lost profit (15.5% times net sales of $1,224,389). If these costs had been kept to the same percentages as 2011 the company would have had a profit of $120,789 instead of a loss of $69,990.
Labor is up about 6% and materials are up over 8%.
So we will focus on those two areas as they represent the largest losses.
What issues caused the labor to rise? Are you hiring new employees, using casual labor or does this represent overtime? How can the labor costs can be managed better?
Why are materials rising as a percentage?
Materials should decline slightly as a percentage since you should be able to take advantage of discounts for larger orders. His key supplier had offered no discounts as volume rose and convinced the owner that his pricing was below market.
After lengthy discussions, much research and the involvement of key employees, the owner determined that his seasonal business would benefit by using casual labor during the high season which would, in turn, reduce overtime expense. He had rightly decided that due to the seasonal nature of the business, hiring full time employees would be too costly. However, his overtime expense had mushroomed as the company’s high season lengthened from three months to five. Casual, part time labor was less expensive than overtime.
The materials cost was more problematic and hinged on the owner’s relationship with his key suppliers. He needed to acknowledge that the suppliers were not his friends and make a concerted effort to find other suppliers who valued his business. Once other suppliers were identified he could pressure the original supplier for discounts if he chose. If he were able to get materials cost to the 21% it had been two years earlier, he would have had $123,425 in additional gross profit. Logically, the current materials percentage should have been below 21% as the larger business should able to command better prices.
In a short period we were able to identify his key problems and begin looking at solutions. The Profit and Loss Statement is a first tier diagnostic tool for your business.
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