| EXECUTIVE SUMMARY |
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| 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.
