Use Your P&L Statement to Make Better Decisions

Originally published by the following source: SBC MagazineAugust 12, 2019
by Jess Lohse with contributions from SBCA Staff

   

Component Manufacturing (CM) operations exist in all shapes and sizes and range in sophistication from large publicly traded corporations to small family operated business, or even side businesses to other related supply or service operations. In all these businesses one common similarity exists, the goal to show a profit from manufacturing components. While production methods and means are well understood across the CM industry, understanding how a variety of costs and expenses impact overall profitability can be extremely complex in a mass-customization manufacturing environment. 

The best tool to track and understand expenses in any business is an income statement often referred to as a profit and loss (P&L) statement. Many different formats exist for P&Ls with the majority broken down between financial accounting and managerial accounting formats. Financial accounting is typically performed for tax purposes and adhere to GAAP standards. CPAs, controllers, bookkeepers or other staff positions will generate these reports on an annual basis (at a minimum) to distribute to stakeholders external to the business. Managerial accounting, alternatively, focuses on operations and analyzes how particular divisions, products or processes are performing and are tools for evaluating efficiencies or profitability of specific sectors within the business. These reports are intended to be used by internal company management and not to be distributed outside of the company. 

A typical financial accounting P&L will start with the entity’s name at the top and a reference for which time period the statement covers. P&L statements will cover a specific length of time, be it one day, one month, a quarter, a year or any combination. The top section is typically related to sales or revenues for the business.  Gross sales will be noted on a top line with any discounts or allowances designated by its own line.  The difference of these two will be denoted as net sales. The cost of goods sold (COGS) are typically listed next and include any direct expenses. Generally these are raw materials and labor costs allocated directly to the production or purchase of the items sold in the P&L top line revenue. The difference between net sales and COGS is known as gross profit

Beyond COGS, other expenses are then listed that may include delivery expenses, selling or customer service expenses, administrative expenses and other indirect (meaning not directly tied to the product being manufactured) expenses. Net operating profit is the difference of gross profit from these indirect/overhead expenses. 

Other expenses such as non-operating expenses or interest expense are then listed and subtracted resulting in net income or loss (if total expenses exceed revenue) for the time period for which the report covers. 

Indirect Expense: Indirect expenses are those expenses that are incurred to operate a business as a whole or a segment of a business, and so cannot be directly associated with a cost object, such as a product, service or customer. 

Direct Expense: Direct expense is an expense incurred that varies directly with changes in the volume of a cost.  Direct expenses are typically listed within the cost of goods sold section of the income statement.

Most businesses are required to create a P&L on an annual basis for a variety of purposes. In the 1990s, anecdotally it may have been common for CMs to look at their profitability on an annual basis. However, in today’s business environment,  a year is a very long time period to not know the overall health of a manufacturing operation. 

Quarterly (every 3 months) P&L statements provide greater insight and allow decisions to be made as seasonal adjustments to business operations are required. Beyond that, monthly P&L statements, and taking the time to fully understand them, is a best practice that offers direct insight to change performance in the near term should revenue or expenses trend in an undesired direction. 

Investing time each month to fully understand an operation’s performance will allow management to make fluid decisions to improve critical operations and fully capture expenses and their overall effect on the business. 

SBCA is offering Business Solutions Groups (BSG) geared specifically to expense management and understanding P&L statements. If you are interested in participating in one of these BSGs please contact Jess Lohse