An owner of a hair salon needs a well organized and properly formatted profit and loss statement (income statement) to properly evaluate performance. There are multiple presentation formats used in the service industry, but after 25 years of accounting I advocate for the functional presentation arrangement. This form of a profit and loss statement allows the owner to quickly and decisively determine performance throughout the entire operation.
The functional presentation arrangement breaks the salon business down into two or more areas of activity. The traditional hair services is customarily one and other may include:
- Retail Products
The value of this organizational presentation is the ability to break the business down into profit centers. Essentially, the owner wants to know how each area of operations is performing. To illustrate this let’s first look at the traditional presentation format.
Traditional Presentation Format
Profit and Loss Statement
For the Month Ending October 31, 2016
Sub-Total Adjustments (3,693)
Net Sales 114,714
Cost of Sales/Services:
Equipment (Deprec.) 4,803
Sub-Total Costs of Sales/Services 77,182
Gross Profit 37,532
Sub-Total Expenses 29,467
Net Profit $8,065
At first glance it looks very informative. It clearly breaks out costs and expenses based on groups of costs. For example, ‘Facilities’ include:
- CAM Fee
But does this presentation clearly identify which functions of business performed well or poorly? Does it illustrate the profit for retail or hair services?
This is when a functional presentation is so valuable to a hair salon owner. Before I illustrate this presentation organization, I need to first explain class accounting.
Class accounting is a form of entering data into the accounting records and assigning both revenues and costs to classes (divisions/departments/profit centers). General expenses are not assigned to a class because they are not directly attached to any particular department; e.g. think of utilities or insurance. Most often, general expenses benefit all the departments equally or are shared as a necessary cost to have all the departments.
QuickBooks uses the term “Classes” and this function is turned on in ‘Edit Preferences’ in the accounting section. In ‘Lists’ classes are then available, simply identify your classes (profit centers). As you enter sales or costs assign the appropriate class to the entry for each debit and credit entry line.
Now that you understand the term ‘Class’ let’s look at a functional profit and loss statement.
Functional Profit and Loss Statement for the Hair Salon
This illustration uses the same information from the traditional presentation above.
Profit and Loss Statement by Class
For the Month Ending October 31, 2016
Hair Spa Retail Total
Sales $71,280 $36,508 $10,619 $118,407
Discounts (410) (887) (104) (1,401)
Coupons (547) (1,690) (55) (2,292)
Net Sales 70,323 33,931 10,460 114,714
Cost of Sales:
Commissions 42,398 14,004 806 57,208
Product 2,209 -0- 4,210 6,419
Backbar 6,827 1,183 -0- 8,010
Equipment 1,956 2,740 107 4,803
Supplies 266 391 85 742
Gross Profit $16,667 $15,613 $5,252 37,532
Taxes & Licenses 3,603
Net Profit $8,065
One of the first steps in evaluating a functional profit and loss statement is to review the respective class gross profit as a percentage of net sales (gross margin). Do not use gross sales as the denominator; net sales is the correct variable. Here are the results:
Hair Spa Retail Total
Gross Profit % 23.7% 46.0% 50.1% 32.7%
Based on the results ‘Retail’ generates the highest gross margin per dollar unit. But this class of sales is not the primary source of business for Bangs. It is merely an ancillary source of revenue. It would be nice to double the volume but it is unrealistic to believe this is possible. The sole source of customers are the clients visiting the shop for hair and spa services. Rarely if ever does a customer walk in to the salon to just purchase retail products.
The most interesting of the three classes is the ‘Spa’ division. Its percentage of gross profit to sales is 46%. A 46% profit margin in the service industry is outstanding. Imagine a $10,000 increase in net sales in this class. The additional gross profit is $4,600 and there would be no additional general expenses incurred (maybe a few dollars with marketing/advertising). This $4,600 would improve the bottom line significantly adding to the owner’s wealth. There is no doubt that more attention is needed with increasing sales for the ‘Spa’ services in this salon.
The ‘Hair’ division is typical for your average salon. But more than likely the customers for spa services are a direct reflection of the hair services. That is, the bulk of customers buying spa services are the existing hair clients. Increase the volume of hair clients and spa services will naturally follow suite.
What is also interesting is that if you increase the volume of clientele for either hair or spa, it benefits the other department as well. Furthermore retail sales will increase too.
The functional presentation format allows the owner the opportunity to look at each class separately and the business as a whole via the total column. Notice no expenses are assigned or allocated to the different classes. It isn’t really necessary nor will any real benefit be derived. This is mostly attributable to the fact that expenses are generic in nature and serve each class in almost a direct proportion to their respective sales. Also to allocate these expenses correctly requires the use of functional formulas normally taught to accountants in advanced classes. There would be very little to gain for a small business to take this unnecessary step.
The real value from this organizational structure is the ability to analyze each class separately and in relation to each other. Here is my short list of some information I absorbed from the report:
- Hair services generated the greatest volume of absolute dollars for contribution margin. Although its gross profit percentage (margin) is just shy of 24% and is the lowest margin of the three classes it is still number one for contributing dollars. It is this service that supplies the customers for the other two classes.
- Spa services rely on coupons and discounts to entice customers to purchase these services. This isn’t a bad thing it may mean further experimentation with different types of incentives (discounts and coupons) to determine the effect on sales.
- Some of the product available or purchased for retail is used in the hair class as a cost. This particular store allows the customer to select their color out front in the retail area for use in the hair service. This slightly distorts the performance for both hair and retail. Retail didn’t get the credit for this sale and hair’s gross profit percentage is slightly leveraged higher because of the higher retail profit percentage associated with these product sales. Overall it isn’t significant but if hair services were to hit $250,000 per month, the owner should consider shifting these particular sales of product over to retail.
The organizational structure uses several lines in the cost of service/sales section that are common in all three classes of income.
- Commissions – Labor for all three departments
- Equipment – Maintenance and depreciation for all three segments. Notice ‘Spa’ is the highest and this a direct reflection of the use of more expensive equipment utilized in the spa class of business.
- Supplies – Everything from lotions to cleaning agents and towels are included here. Supplies include tags, markers for retail, aprons and new blades for cutters in hair to soaps/oils for the spa.
Summary – Best P&L Format for Salons
Overall the functional organization format is the best presentation method to present the profit and loss with a hair salon. It breaks the salon out into the primary classes of sales and identifies their corresponding direct costs. With this information management can easily determine performance of each class of sales. In addition, relationships between the departments are evaluated and programs can be designed to enhance sales for the more profitable work centers. Act on Knowledge.