Cutting Financial Reports Down To Size

Information that really tells the story.
BY JACK L. OTTENHEIMER

EXECUTIVE SUMMARY

  • MOST MANAGERS get inundated at meetings (and elsewhere) with so much financial data that they lose sight of the big picture. It would be better to provide them with financial data in summary or highlighted form. If managers need details, that data can be provided separately.

  • PRESENTING INFORMATION in summary form doesn’t mean you can take shortcuts when preparing financial statements.

  • SUMMARY PRESENTATIONS should focus on significant indicators such as: pretax net income, key operating information, sales, costs and variances from budget.

  • DETERMINING WHICH IMPORTANT expenses to break out is the art of designing an effective key indicator report. Analyze variances in the P&L by comparing several periods and then decide on the items to segregate on the report.

  • SUCH SUMMARIES are especially helpful for growing companies, which need to focus on key indicators and exception reporting.

  • THIS KIND OF financial information and the commentary on notable items, trends and variances from the forecast provide a clear financial picture that’s easy to understand. And it keeps everyone focused on the big picture. Significant variances or trends can be addressed separately.
    JACK L. OTTENHEIMER, CPA, is vice-president, finance and CFO of ABL Electronics Corp., Hunt Valley, Maryland. He is a past chairman of the management of an accounting practice committee of the Maryland Association of CPAs. His e-mail address is jotten@charm.net .



    Have you ever attended a meeting of corporate brass where the CFO read the income statement line by line and every so often someone asked for an explanation? Although the information conveyed is important, such meetings can be interminable. If you tallied the total per-hour compensation of the attendees, you might wonder whether there’s a better, and much cheaper, way to communicate this information.

    The good news: There is.

    The better news: The solution is simple and fast and adds no cost to finance department operations.

    Even better news: Each person at the meeting will come away with information he or she really needs, no more, no less.

    LESS DATA, MORE INFORMATION
    If you’re the CFO or the staff person who prepares the financial report for that meeting, ask yourself: What kinds of information do the meetings attendees really need? In my experience, most managers need only summarized financial data. Details can be provided separately for those who need them.

    However, and this is critical, just because the information is summarized, don't assume you can take shortcuts in preparing the statements. In fact, you also should prepare a thorough comparison of monthly expenses. That data should be compared with forecasts and then distilled into a brief, informative presentation focused on significant indicators: pretax net income, key operating information (each company has its own set of key data), sales, costs and variances from budget. Determining which indicators to break out is the art of designing a key indicator report.

    A typical financial summary report would contain balance sheet and income statement summaries, a break-even analysis, charts of key ratios and the following key financial information:

    Pretax net income: current month $_______
    Pretax net income: year to date $_______
    Cash $_______
    Line of credit: balance $_______
    Line of credit: available $_______
    Retained earnings $_______

    In addition, the report would include variances from budget such as

      Amount   Comments  
    Bonus accrual $_______    
    Trade show $_______    
    Depreciation $_______   Year-to-date
    adjustment due
    to purchase of
          ___________.

    And it would include data on trends and comments, for example

    • Packaging supplies are trending up.

    • Gross profit is down by _______% for two months, need to evaluate.

    • Monthly net sales level is $__________ over (under).

    • Monthly gross profit is up (down) _______%.

    • Resulting gross profit is $__________ over (under).

    • Expenditures that are over budget:
          Travel and entertainment are over by $__________.

    The summarized income statement and balance sheet each should take no more than one sheet of paper. The break-even calculation is especially helpful to growing companies because they have a tendency to pick up overhead easily. Use graphs and ratios to highlight significant information.

    Taken together, these data provide a clear financial picture that’s easy to understand without being overly technical. But more important, the report keeps everyone focused on the big picture without being distracted by the details. Any significant variances or trends can be addressed separately.

    THE GAAP GAP
    GAAP financial statements are uniform and therefore provide a level playing field for the users of financial information such as bankers or investors. Because of our training, we accountants may feel strange preparing statements that aren’t strictly in accordance with GAAP. Corporate managers, however, find such reports useful because they focus primarily on trends.

    Take employee compensation in a manufacturing company as an example. Such expenses are spread throughout the income statement, generally in each of the cost areas: direct and indirect, selling and marketing, indirect labor and general and administrative. Compensation may be broken down further into officer, supervisory and staff compensation. In a typical report, such costs get buried within the overall costs for the respective departments. Likewise for rent expense, which typically is coded to the respective profit center or location and allocated among various departments. In both cases, the big picture is hidden. From managements point of view, the more departments, the more complex the statements and the more key information is buried.

    Standard Income Statement Format
      1/31/98 2/28/98 3/31/98 Three-month total
    Net sales $445,000 100.00% $418,500 100.00% $565,500 100.00% $1,429,000 100.00%
    Cost of goods sold 284,900 64.02% 238,220 56.92% 327,400 57.90% 850,520 59.52%
    Gross profit 160,100 35.98% 180,280 43.08% 238,100 42.10% 578,480 40.48%
    Selling and marketing expenses 103,200 23.19% 70,000 16.73% 105,600 18.67% 278,800 19.51%
    General and administrative expenses 57,464 12.91% 59,228 14.15% 66,464 11.75% 183,157 12.82%
    Net income from operations (564) -0.13% 51,052 12.20% 66,036 11.68% 116,523 8.15%
    Other income and expenses 0 0.00% 0 0.00% 0 0.00% 0 0.00%
    Net income before taxes (564) -0.13% 51,052 12.20% 66,036 11.68% 116,523 8.15%
    State income taxes (40) -0.01% 3,574 0.85% 4,622 0.82% 8,157 0.57%
    Federal income taxes (178) -0.04% 16,143 3.86% 20,880 3.69% 36,845 2.58%
    Net income ($346) -0.08% $31,336 7.49% $40,533 7.17% $71,522 5.01%
     
    Key Indicator Income Statement Format*
      1/31/98 2/28/98 3/31/98 Three-month total
    Sales $500,000 100.00% $450,000 100.00% $650,000 100.00% $1,600,002 100.00%
    Sales returns 25,000 5.00% 18,000 4.00% 39,000 6.00% 82,000 5.12%
    Sales incentives 30,000 6.00% 13,500 3.00% 45,500 7.00% 89,000 5.56%
    Cost of goods sold materials 270,300 54.06% 219,300 48.73% 306,000 47.08% 795,601 49.73%
    Cost of goods sold indirect 1,200 0.24% 3,240 0.72% 2,300 0.35% 6,740 0.42%
    Selling and marketing expenses 13,300 2.66% 13,400 2.98% 13,600 2.09% 40,300 2.52%
    General and administrative expenses 15,041 3.01% 15,074 3.35% 19,041 2.93% 49,157 3.07%
    Other income and expenses 0 0.00% 0 0.00% 0 0.00% 0 0.00%
    Key expenses broken out:                
    Compensation 82,500 16.50% 91,000 20.22% 107,500 16.54% 281,000 17.56%
    Payroll taxes and fringes 8,223 1.64% 9,434 2.10% 11,023 1.70% 28,680 1.79%
    Rent 7,000 1.40% 7,000 1.56% 7,000 1.08% 21,000 1.31%
    Trade shows 30,000 6.00% 5,000 1.11% 22,000 3.38% 57,000 3.56%
    Travel and entertainment 18,000 3.60% 4,000 0.89% 11,000 1.69% 33,000 2.06%
    Net income before taxes ($564) 20.11% $51,052 11.34% $66,036 10.16% $116,523 7.28%
    *Percentages may not total 100% due to rounding.
    Which income statement tells you more about the company, the top report or the bottom one? The bottom report focuses on the key indicators that affect the operation of the business.

    FLUCTUATING COSTS
    Suppose some marketing expenses are subject to large year-to-year fluctuations while most of them stay the same. Instead of analyzing these fluctuations each period, why not just make them line items on a summary income statement? The expenses that don’t fluctuate significantly can be grouped together. Using that strategy provides an income statement that highlights larger categories of expense, those that fluctuate greatly, and manageable expenses.

    Of course, a summarized report doesn’t replace a GAAP income statement, but it provides additional information that’s very useful to managers of the business.

    Below is a sample of such a report. Cost of goods sold, the general and administrative figures and selling and marketing categories are shown net of compensation, payroll taxes, fringe benefits and rent. Assume that compensation is the largest expense other than materials and that overtime and incentive compensation triggers large fluctuations. Also, assume that travel and entertainment and trade show expenses vary greatly from month to month, causing the income statement to fluctuate greatly. These expenses can be broken out into line items.

    Recast Income Statement
      Month/Year Year to Date
      $         % $         %
    Net sales        
    Cost of goods sold        
    General and administrative        
    Selling and marketing        
    Other income        
    Key expenses broken out:        
        Compensation        
        Payroll taxes and fringes        
        Rent        
        Travel and entertainment        
        Trade shows        
    Net income before taxes        

    In sum, business entities, especially growing companies, need cost-effective operational and financial data that focus less on details and more on key indicators and exception reporting. This approach is advantageous for CFOs in two ways:

    • It takes very little extra effort to prepare the summarized reports.

    • It reinforces what only the finance department can provide corporate leaders: a sure-fire tool to help them fulfill their main responsibility, keeping their eyes trained on the big picture.

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