Profit and Loss Statement Using Class Accounting

Class Accounting

Class accounting breaks down sales and the associated cost of sales into functional groups.  Whether you use divisions or departments or product/service lines class accounting allows you to identify those more profitable areas of operations.  This is just one of the many different financial reports used in small business.

To help you envision class accounting I’m going to site some common small businesses and their associated classes:     

            Business                 Classes
             Legal                    Criminal
                                           Contracts/Real Estate
              Salon                    Service
             Dealerships           New
                                            Finance and Insurance
             Landscaping         Design/Build
             Alcohol Retail       Spirits
             Restaurant             Refreshments

Class accounting allows the management team to review sales and associated costs for those sales to discover the more profitable lines of business and ascertain why.

The best tool is breaking down the income statement (profit and loss statement) into classes.  Before I continue explaining this I’m going to first explain the difference between a traditional profit and loss statement and a functional profit and loss statement.

Profit and Loss Statement – Traditional Presentation

In the traditional presentation format the profit and loss statement identifies total sales and total costs to determine the gross margin.  But it still doesn’t tell the owner which segment of his business performs the best.  Take a look:

            Profit and Loss Statement (Summary Format)
                     For the Month Ending June 30, 2015 

Sales                                                                    $97,205
Adjustments                                                         (6,511)
Net Sales                                                              90,694
Costs of Entertainment (COE)                         (27,407)
Gross Profit                                                          63,287
Expenses                                                             (31,018)
Profit                                                                  $32,269 

Functional Profit and Loss Statement

In your traditional profit and loss statement expenses are included.  With class accounting expenses are not included because expenses cannot be assigned or allocated among the respective classes.  Think of the above entertainment venue.  The business leases the land and building.  How do you allocate out the payment?  It is simply and expense and not in costs of entertainment.  So a functional report’s bottom line is the gross profit.

All sales and costs of entertainment can be directly linked to the respective entertainment activities.  Take a look: 

                                GOLF and GAMES ENTERTAINMENT
                Summary Functional Profit and Loss Statement by Class
                                For the Month Ending June 30, 2015 

                           Driving Range    Putt-Putt      Games      Total
Sales                      $59,353               $33,743       $4,109     $97,205
Adjustments           (4,699)                 (1,802)           (10)      (6,511)
Net Sales                 54,654                 31,941         4,099       90,694
Costs of Entert.       (9,256)                (14,980)      (3,171)    (27,407)
Gross Profit           $45,398                 $16,961         $928      $63,287

Now management has some real valuable information to use for decision making.   Obviously the driving range is the real bread and butter for earning money.  Its cost to operate per dollar or sales is significantly lower than the other two divisions.   The gaming area can be scrutinized further for an understanding as to why its gross profit as a percentage of sales is so low.

But clearly this profit and loss statement by class is so much more informative than your traditional presentation.

Full Functional Profit and Loss Statement by Class

With a full profit and loss statement in detail format separated by classes a reader of information can clearly identify issues or benefits related to operations.  Let’s take a look: 

                             GOLF and GAMES ENTERTAINMENT
                            Detail Profit and Loss Statement by Class
                                One Month Ending June 30, 2015 

                                 Driving Range   Putt-Putt    Games     Total
Sales                             $59,353           $33,743      $4,109    $97,205
   Group Discounts                                     (463)          (10)        (473)
.  Campaigns                    (4,699)            (1,339)          -0-       (6,038)
Net Sales                        54,654              31,941        4,099      97,205
Costs of Entertainment:
   Labor                            3,644                5,118           -0-         8,762
.  Equipment                     1,071                3,767            214       5,052
.  Depreciation                  4,334                6,040            106     10,480
.  Supplies                           207                     55              97         359
.  Commissions                   -0-                     -0-          2,754       2,754
Gross Profit                   $45,398            $16,961          $928   $63,287
       Management                                                                       9,107
.      Facilities                                                                            4,419
.      Insurance                                                                           2,010
.      Office                                                                                     81
.      Capital                                                                              15,401
       Sub-Total Expenses                                                            31,018
Net Profit                                                                               $32,269 

Typically the accountant explores net sales first when analyzing the report.  In this business management uses campaigns (marketing and advertising) to attract customers.  In this case coupons were used for a Buy One Get One Free (BOGO) for the driving range.  No specialty programs were used for Putt-Putt other than the standard multiple game discounts and acceptance of older campaign coupons.  By comparing previous month and last year’s same month financial reports management can evaluate campaign performance.

In the costs of entertainment section the one item that stands out for games is the commissions paid for use of the different machines.  Instead of purchasing the machines and independent owner sets them on site and is paid a percentage of the actual earnings.  Given the low profit this class of operations generates alternative sources of revenue should be considered.  Examples include an ice-cream soda fountain set-up, refreshment stand or even a cafe.

What is surprising is the value the driving range brings to the business.  Not only are sales almost double of Putt-Putt both the costs to operate are two thirds of Putt-Putt making the driving range a true leader in performance.

So the question is why or how to improve Putt-Putt.

Let’s explore just one possibility.

Look at depreciation cost for both the driving range and Putt-Putt. A good accountant will evaluate the underlying capital costs associated with this depreciation.  In this case the driving range uses a longer depreciation cycle in comparison to Putt-Putt.  This lowers the depreciation amount per accounting period reported.  This would also mean that the underlying loan to build the complex has greater portion of its principle borrowed to build the driving range.  Then this means that down in expenses under capital expenses the dollar value for June is interest to service the debt.  Most of this interest is attributable to the driving range.  So in reality when factoring in the cost of capital the costs to operate the driving range are almost comparable to the Putt-Putt profit center.  However, the volume of sales for the driving range still solidifies its position as the best class of income for the company. 

Summary – Class Accounting

Based on the information deciphered from this report an accountant would most likely suggest greater emphasis on increasing sales for the Putt-Putt department.  Can a campaign with Putt-Putt work as well as the campaign did for the driving range?  The key is to use the information reported and test different alternatives and monitor the results.  This is how small business uses the profit and loss statement by class to create a continuous feedback loop of good information.  ACT ON KNOWLEDGE.

If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol)  I would love to hear from you.   If interested in my help as an accountant or consultant, contact me through the ‘My Services’ page in the footer.

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