Tag Archives: Questions/Answers

P&L’s – The most important number?

Ask an Expert, Operations, , , ,

I received a question about  our recent post regarding Financial tools every business needs regarding the Profit and Loss Statement.

The question is…

” Which is the single most important number to help manage your business on the P&L?”

The answer quite simply is the “% Variances” column.   Not all P&L reports even have that so what is it?  To truly have an idea where your business needs to be, you need to start with creating a budget.  Every line on a P&L should have a “budgeted amount”  number in it.  This is the amount you expected to spend to yield the profit you planned.  If you don’t do the work to create a budget, then the P&L looses half of its value as a tool to help your businesses ability to generate revenue.

Many know that to help manage your business you compare the “Actuals” to the “Budgeted” columns for each line.  But there should also be a percentage column next to each of these showing the percent of total revenue that each is, which isn’t as common to find in smaller businesses P&L.  It is important to do this because Percentages reflect day to day execution of the operations in your business.

The VARIANCE column shows the difference between the budgeted and actual dollars spent, which should also have a % Variance column next to it.  This is an excellent “At a Glance” illustration of how you did in that area for the given period (+/-).

The variance dollar columns are great information for when you need to “dig in” and find why an area was high or low, but comparing that areas “actual” percent to the percent of “budgeted” revenue….

is the single most telling number for performance.

Example:

Sales are up, which would likely mean some controllable expenses are up, right? But how much more should you spend to maintain your margins?  Management needs to make sure expenses are still with in the Budgeted percentage of sales to maintain profit levels as expected.  Simply put if you expected to spend 20% of your expenses on materials, you should still spend 20% on materials whether sales go up or down.  This column helps you keep an eye on that and make adjustments if necessary.   Businesses that have a lot of fluctuation tend to run these reports more often (Food, Retail, etc).  This helps you control your product costs.  Granted, this may also mean that profit dollars are down (assuming revenue is down), but at least you maintain product and fiscal integrity.  That is very important which I have a lot to say about as well as how to impact these numbers, but I will save that for another time.

But the SINGLE most important number, one that a Business Analyst or Owner should focus on first is the % Variance to budgeted because it shows so much information.

Call me if you need help with this, my number is at the bottom of our Contact page.

Carpe diem!

Ask an Expert

Ask an Expert, ,

The Question:      What are Prime Costs?

Answer: Financial speak

Prime costs = materials + labor

Prime cost is a GAAP (Generally Accepted Accounting Principles) term that refers to the costs of all materials plus the labor needed to create your product.  They are called prime because of the effect they have on profitability.  They are the “primary” contributors to your profits.

In many circles this may be referred to as “Controllable or Variable Costs”, because you have the greatest flexibility to control your profit with them.  The organization controls what you pay your labor and you can work with vendors around pricing of materials.  Most other costs in this scenario would be deemed “Non Controllable Costs”, such as rent, taxes, or utilities.  Some argue that rent is negotiable, therefore controllable, once it is agreed upon it doesn’t change unless negotiated again and therefore it is considered a non controllable.

Many industries break down the label of “materials” to other labels or set formulas specific to that industry.  But “Prime costs”  will always be cost of necessary materials(or services) and labor in the end.

For example;

Prime costs in a manufacturing business may include a distribution channel cost because of the costs associated with marketing it, the marketing is necessary to the distribution of that particular product and with out those costs the product would not get to market.  It is essential yet controllable, so it is a prime cost.

OR

Prime costs in the restaurant industry are known as the “Big 3” Food, Labor, and Liquor”, while there are other controllable costs these are the 3 that have the most effect on profits.

and so on…..

Carpe diem!