My Financials Are Good … Compared To What?
A basic financial commandment is that companies must produce an accurate and timely profit and loss statement and balance sheet each month. My role as a business coach for Nexstar gives me the opportunity to review dozens of financial statements. What I have found is that most members are producing an accurate and timely financial statement each month.
What does this tell you? Is this company getting better or worse? If it is getting better or worse - why is it getting better or worse? How does it compare against the expectations of the owner? The truth is, based on this P&L, you just don’t know. It is only a point-in-time snapshot of the business. There is just not enough information. Yet, for many owners, this is all that is reviewed.
You Vs. YouAt a minimum, every monthly and annual P&L should be compared against prior-year, same-period performance. Let’s take a look at this same P&L, only this time we will compare it against the same month in the prior year (Table 2).
Now what can you decipher from this P&L? The real question is, where do you start? It is rich in information. Let’s do a real quick P&L review:
• Revenue - Up 5 percent, which is a good trend. Naturally, you will want to review staffing levels, call count, average ticket and closing rate data before you declare victory.
• Gross margin - Still at 59 percent. But if you dig deeper, you see that labor is up 1 percent - something to watch - and material is down 1 percent. So from this review you may want to check payroll, overtime, discounting, work mix, etc., and find out why payroll went up as a percent of sales.
• Overhead expenses - In total, only up 3 percent from the prior year, which is slower growth than both sales (+5 percent) and gross margin dollars (+4 percent), meaning we are getting leverage on overhead, which is good! However, there is something to watch out for - vehicle expenses are up significantly.
• Profits - Up a modest $1,300 due to 5 percent sales growth, steady gross margin percentage and slower overhead expense growth than revenue. All in all, better performance than prior year! A win, right?
Take it up a notch and compare your company against your budget. A dirty secret is that while many PHC owners receive accurate and timely monthly P&Ls, not many have a budget. But for the sake of this column, let’s assume the sample company has a budget (and if you don’t you should feel very guilty - you are cheating yourself and the business out of better company performance).
Now let’s look at this same P&L, but with a comparison against budget (Table 3).
Now what does this comparison add to your analysis?
• Revenue - When we just looked at comparison against the prior year, we thought 5 percent revenue growth was pretty good. However, we fell $5,000 short of budget! What didn’t work as planned? Was it call counts? Was it staffing? Was it the fact that we spent $1,000 less in advertising than we budgeted? While we improved over the prior year, we missed an opportunity somewhere. Your job is to find and fix it.
• Gross margins - We had budgeted a nice 2 percent increase in gross margin to 61 percent, but ended up 2 percent short and it was all direct labor, which was up against budget and prior year - a double whammy. Now it is time to dig in and figure out how we not only missed budget, but got worse than last year. Alarm bells should be ringing in your company and all hands on deck to get direct labor in line.
• Overhead expenses - In total, overhead was only up $500, but look a little deeper. Despite budgeting higher office salaries and vehicle expenses than the prior year, we still exceeded budgeted expenses. What went wrong? How do we fix it so we don’t run over every month? Let’s take care of a negative trend early before too much money and time are lost.
• Profits - Remember when we were only comparing against the prior year and we improved and thought this was a win? We fell significantly short ($5,900) of budget. It was a miss across the board - revenue off budget by $5,000, a big gross margin miss and slightly higher overhead expenses. What we thought was good overall performance ends up being a modest disappointment because we did not perform as we had promised in our budget.
Your goal as the owner should be to become as comfortable with the numbers in your financial statements as you are with the tools and equipment on your truck. Here are some hints to keep in mind:
• Compare against the same period in the prior year. While a month-to-month comparison is good (comparing March to April as an example), due to the natural seasonality of our business, you must also compare your current performance against the same calendar period in the prior year. As an example, September is a very different month than October in the heating business and if you just compare your October performance to September, you may get a false sense of improvement.
• Consider seasonality when setting monthly budgets. When creating monthly budgets, do not take your annual budget and divide by 12. Use a trailing three-year history of revenue and expense trends by month to determine what percentage of your annual budget each month should assume. Your budget must be realistic and historically accurate for it to have any impact on your business.
• Don’t let accounting software limitations prevent you from creating a comparative P&L. It may sound like more work than it is worth, but if you can’t automatically create P&L statements with prior year and budgeted comparisons, create one manually each month on Excel. It is worth the effort.
• Have a second set of eyes review your P&L and balance sheet. While it is vital that the owner review the P&L monthly, it doesn’t hurt to have an additional reviewer as well. Share your P&L with your management team. Have them do their own independent analysis. Ask a trusted CPA or independent consultant familiar with your business to perform regular monthly P&L reviews. Large companies routinely run each P&L through at least two sets of eyes. You should, too.
If you want to run a profitable, growing company, you must understand your numbers - which way they are moving and how they compare to the prior year and your budget.