Poorly structured financial reports stymie a company’s forward movement, but there exist steps CEOs can take to fix the problem.
In my last blog, I noted some 80 percent of small and medium-sized companies are hamstrung by poor financial reporting. If you are the CEO of a company suffering from this problem, I urge you immediately take the step of convening a very serious meeting with your in-house or outside accountant.
As a CEO, you may not know exactly how to classify revenues. But you do know that understanding how much revenue is coming from each of your product lines is imperative. Convey that objective to your accountant. It may require your in-house accountant work with your outside accountant to restructure the chart of accounts used to code and classify transactions in the financial statements.
Once you’ve gone this far in segregating revenue streams, you will next want to learn the gross profit associated with each of those streams. This will help determine which revenue streams should be given additional effort and capital to make them even more robust, or if entirely new streams should be launched.
In addition, you must discuss with your accountants the proper classifications of expenditures. This decision will help determine what direct costs are associated with generating each revenue stream, and what overhead costs exit.
Once you as CEO understand what you are hearing from your internal and external accountants, you will better understand where all this time and effort is headed. It is headed toward creating a vastly improved reporting system, with the objective of using it to make better-informed decisions.
I’ve seen some CEOs react with shock when presented with never-before-segregated revenue streams and their associated costs. “Oh my God!” they exclaim. “ I’ve got to eliminate some SKUs, some product lines. They’re just not profitable to continue selling.” Or, they may respond, “The margins on some of these SKUs are just so low that I will have to increase my prices.”
Now you can look into each stream, examine the number of items comprising each of those streams, and decide which SKUs don’t justify any additional sales effort.
What’s more, if you know you have a good product the marketplace clearly wants, you can make a better decision on adjusting its price.
It all comes down to better informed reporting. As CEO, you can now devote your energies to building profitable sales growth, and sleep better each night knowing your numbers make sense.
If you’d like to sleep better at night, get in touch. I offer a 100 percent guarantee on my work. I take on only clients I can help. Call me and let’s talk about your business. My phone number is 630-269-7646.
The most important elements of informative financial statements are 1) a well-defined Chart of Accounts and 2) an insightful classification (positioning) of totals in the financial statements.
Let’s take a look at how these elements are applied to a great Income Statement.
Sales: Each major product and/or service line should have its own account so sales for each are displayed on the face of the statement.
Direct Costs (COGS, COS): Direct costs are those that vary with the volume of sales and would not be incurred if sales did not occur. Examples are labor (and related payroll taxes), materials, subcontractors, royalty or licensing fees, and sales commissions. Codes for Direct Costs should correlate with the codes for product (or service) lines in Sales.
Gross Profit $ and Gross Margin %: With Sales and Direct Costs by product line, you can calculate the Gross Margin % by product line. This tells you at a glance which lines are profitable and which are drains. Also, accurate Gross Margin percentages can be used to make informed business decisions (see Issue #5—Using Breakeven for Decision Making).
Overhead (relatively fixed operating expenses): All operating expenses that are not classified as Direct Costs should be coded into clearly-defined Overhead accounts.
Income (Loss) From Operations: This number is Gross Profit minus Overhead. In investment and valuation circles, this number is called EBITDA—earnings before interest, taxes, depreciation, and amortization. It also represents Cash Flow from Operations. Businesses are most often valued at a multiple of EBITDA.
Other Income (Expenses): This is where all non-operating and non-cash items should be coded and classified, including interest income, interest expense, income taxes, depreciation, amortization, gain (loss) on sale of assets, and any other income/expense that is of a non-operating nature.
Net Income (Loss): Your bottom line is where all the chickens come home to roost. Are you healthy?
Financial reports are a lens through which you assess your present position and set your future course. You can refine that lens by taking your financial reports from good to great.
The Wisdom of Henry Hazlitt (1894-1993)
A hoodlum breaks the window of a baker’s shop. Onlookers decide that the vandalism has a bright side: a glazier will make $250 repairing the window.
Hazlitt disagrees. The glazier’s gain is money that the baker was planning to spend on a new suit. The onlookers did not take into account that a tailor lost a $250 sale and the baker lost a suit. No new employment was added—the scenario is a net loss.
– from Economics in One Lesson