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
                                            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 continuing, the reader needs to first understand the difference between a traditional profit and loss statement and a functional profit and loss statement.

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:

            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
   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, 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.

Value Investing

Do you want to learn how to get returns like this?

Then learn about Value Investing. Value investing in the simplest of terms means to buy low and sell high. Value investing is defined as a systematic process of buying high quality stock at an undervalued market price quantified by intrinsic value and justified via financial analysis; then selling the stock in a timely manner upon market price recovery.

There are four key principles used with value investing. Each is required. They are:

  1. Risk Reduction – Buy only high quality stocks;
  2. Intrinsic Value – The underlying assets and operations are of good quality and performance;
  3. Financial Analysis – Use core financial information, business ratios and key performance indicators to create a high level of confidence that recovery is just a matter of time;
  4. Patience – Allow time to work for the investor.

If you are interested in learning more, go to the Membership Program page under Value Investing section in the header above. 

Join the value investing club and learn about value investing and how you can easily acquire similar results with your investment fund. Upon joining, you’ll receive the book Value Investing with Business Ratios, a reference guide used with all the decision models you build. Each member goes through three distinct phases:

  1. Education – Introduction to value investing along with terminology used are explained. Key principles of value investing are covered via a series of lessons and tutorials.
  2. Development – Members are taught how pools of investments are developed by first learning about financial metrics and how to read financial statements. The member then uses existing models to grasp the core understanding of developing buy/sell triggers for high quality stocks.
  3. Sophistication – Most members reach this phase of understanding after about six months. Many members create their own pools of investments and share with others their knowledge. Members are introduced to more sophisticated types of investments and how to use them to reduce risk and improve, via leverage, overall returns for their value investment pools.

Each week, you receive an e-mail with a full update on the pools. Follow along as the Investment Fund grows. Start investing with confidence from what you learn. Create your own fund and over time, accumulate wealth. Joining entitles you to the following:

  • Lessons about value investing and the principles involved;
  • Free webinars from the author following up the lessons;
  • Charts, graphs, tutorials, templates and resources to use when you create your own pool;
  • Access to existing pools and their respective data models along with buy/sell triggers;
  • Follow along with the investment fund and its weekly updates;
  • White papers addressing financial principles and proper interpretation methods; AND
  • Some simple good advice.

Value Investment Club

Please Signup
Username can not be left blank.
Please enter valid data.
This username is already registered, please choose another one.
This username is invalid. Please enter a valid username.
First Name
First Name can not be left blank.
Please enter valid data.
This first name is invalid. Please enter a valid first name.
Last Name
Last Name can not be left blank.
Please enter valid data.
This last name is invalid. Please enter a valid last name.
Website (URL)
Website (URL) can not be left blank.
Invalid URL
Invalid URL
Email Address
Email Address can not be left blank.
Please enter valid email address.
Please enter valid email address.
This email is already registered, please choose another one.
Password can not be left blank.
Please enter valid data.
Please enter at least 6 characters.
    Strength: Very Weak
    Select Your Payment Gateway
    How you want to pay?
    Payment Summary

    Your currently selected plan : , Plan Amount :
    , Final Payable Amount:
    error: Content is protected !!