Apples to Apples
Originally published: 1/1/10 by Ruth King
What you need to know about your financial statements
You can't make good decisions for your business without accurate financial statements. If someone is inputting the wrong information, or putting it in the wrong locations, then you'll have financial statements which can't be relied upon. Your job as the owner or manager is to review accurate financial statements on a monthly basis. You don't need to know the intricacies of how each entry is made. You do need to know enough to question if the statements don't appear to be right.
First, ensure that the balance sheet balances. Assets must equal liabilities plus net worth. If they don't balance, you can't trust anything on the statement.
Then, if your feeling is that "the statements just don't seem to be right," keep looking. One of my favorite statements is that you have to match "apples to apples." This means that you must match revenues to expenses. It is one of the most common ways that I see financial statements being inaccurate.
For example, if revenues are put in one month and the expenses against those revenues are in another month, you have fruit salad (apples and oranges). You do not want fruit salad. You
If you put revenues in one month and expenses in another month, then you are fooling yourself. Here's what happens: The month with the revenues and no expenses will look like a great month from a profit perspective. You'll be feeling great about the business. The month that has the expenses and no revenues will be a profit loser and you'll feel bad about the business. If there is a sale in one month, then the direct costs for that sale must be in the same month.
Seasonality can mask your opinion of your financial statements. Many times the thought is, "we didn't do enough work so we should expect a loss this month." Even in slow months (from a revenue perspective) your gross margin still should be consistent. There may not be enough jobs to cover the overhead so the financial statements show a loss.
The easiest way to make sure that you have "apples to apples" is to check your gross margin. If the gross margin is not consistent from month to month, you have a problem. If you know that you have revenues and expenses in the same month, then you must dig deeper to solve minor problems before they become major crises. Here are six things that could be happening to your gross margin:
1. Inconsistent job pricing
One job you bid at a 45 percent gross margin. The next job you bid a 30 percent gross margin. The third you bid a 20 percent gross margin because you want the job and you think that it will lead to others ... it may or may not. In slower times of the year, you might make a conscious decision to lower gross margin to win more jobs. If you make this conscious decision, then the gross margin that you sell at should still be the gross margin shown on the monthly financial statement.
2. Missed job estimates
You bid 12 hours on a job and it takes 16. Or, on the positive side, you bid 12 hours and it takes 8. Either way, your gross margin will be affected. Either way, you need to find out why you missed the budget. If you are under budget, find out how to stay under budget. If you are over budget, find out why the estimate was missed and what you can do to avoid that mistake the next time.
3. Callbacks or warranty expenses
You have additional expense with no revenues against those expenses. In the case of warranty, you may recover part of the expense when you submit warranty claims. In the case of callbacks, you have a very little chance of recovering the expenses. This decreases your gross margin.
4. Paying overtime and charging regular time
In busy times of the year, you might have service agreement customers who pay regular rates while you are paying your technicians overtime. Your gross margin will be lower than normal. Yes, you can be busier and make less profit.
5. Expense inventory
You get a large stocking order and expense it. When you order materials for future use it is inventory until you use it. Once that part is used on a job, it is taken out of inventory and put in job expense. You always need revenue to offset the materials expense.
Technicians don't charge customers for parts they use. Or the parts disappear. Theft is usually discovered during inventory counts when the actual inventory is much less than what it is supposed to be based on the balance sheet value. Hopefully, this is not the case in your company.
Make sure that you have "apples to apples" rather than "fruit salad" each month. This is one way to ensure that you are generating accurate financial statements that you can use to make prudent business decisions.
Articles by Ruth King
Understand Your P&L: Overhead
Understand Your P&L Statement: Gross Margin, pt. 2
Gross margin should not vary more than a few points each month. If it does, then you must find out why the margin is varying.
Understand Your P&L Statement: Gross Margin
Understand Your P&L Statement: Cost of Goods Sold
However you decide to categorize expenses in your P&L, it's important to be consistent.
Understand Your P&L Statement: Sales vs. Revenue
Sales are critical to survival — when revenue is actually generated is even more critical.