Profit and Loss Statement Using 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 the reader envision class accounting, the following are some common small businesses and their associated classes:
Business Classes
Legal Criminal
Civil
Contracts/Real Estate
Salon Service
Products
Spa
Dealerships New
Used
Parts
Service
Finance and Insurance
Landscaping Design/Build
Maintenance
Nursery
Arborist
Alcohol Retail Spirits
Wine
Beer
Restaurant Refreshments
Entrees
Deserts
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 continuing, the reader needs to first understand the difference between a traditional profit and loss statement and a functional profit and loss statement.
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Profit and Loss Statement – Traditional Presentation
With 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:
GOLF and GAMES ENTERTAINMENT
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
With the 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 an expense and not in costs of entertainment. A functional report’s bottom line is the gross profit point among the three recognized profit points in a profit and loss statement (income statement).
All sales and costs of entertainment can be directly linked to the respective entertainment activities. Here is an illustration:
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
Adjustments:
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
Expenses
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, but the costs to operate are two thirds of Putt-Putt, making the driving range a true leader in performance.
Thus, 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. 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.
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