Fire your Accountant & Hire a Partner

I swear accountants are the strangest people!  We all want to know how much profit our small business is making, but why care about the losses? Just show me the money! YES….money, that’s why I stay in business. Let’s break it down to understand what you can get from your small business losses (even saying that is weird).

The Profit and Loss (P&L) Statement is also known as the Income Statement. It shows how well a company buys and sells inventory or services, to make a profit. You must create a profit in order to survive, true? As my boring accountant friends might say…..”Careful analysis of the components of a P&L is important in determining the cash flow available to repay existing debt, or finance business expansion, or to reinvest in the company.”  And now we are talking about the money, the money left over!

Your “Balance Sheet” is a snapshot of the financial condition of your company at a certain point in time. Your Profit and Loss statement shows the results of financial operations over a period of one fiscal year. The amount of time that you look at could be a month, a quarter of a year, a half year, or a year.

The categories of a profit and loss statement are always arranged in a specific order . Within each category, revenues and expenses are listed separately or grouped. How you report your categories needs to be the same over a period of time. If you change some expense to different headings year after year, you may raise a red flag with the tax man (don’t upset the tax man).

In this example, each expense category is  either a variable, fixed, or “discretionary” expense (more on this below).

The Cost of Goods Sold (COGS) is the general category for all production related expenses which is subtracted.

Here is a good example from Wikipedia:

Sales——————————— $100,000

Cost of Goods Sold

Inventory at the beginning of the year — $ 5,000

Purchases———— $45,000

Direct Labor———- $30,000

_______

80,000

Less: Inventory at the end of the year —– 10,000

_______

Net Cost of Goods Sold—————- 70,000

______

Gross Profit on Sales—————— $30,000

For a car manufacturer, the COGS would include the raw materials and wages for labor used to produce a car.

Completing the calculation gives us the Gross Profit (Sales – COGS). At this point, production related expenses are covered and the remaining overhead costs your  business has must be subtracted to find out the company’s Earnings Before Tax (EBTx).  Sounds scary but it is much simpler than you may think. The other costs mentioned above (overhead) can include:

• Salaried personnel such as managers and administration clerks
• Travel and entertainment
• Rent
• Utilities
• Postage
• Printing
• Insurance
• Interest
• Association Dues/Subscriptions
• Advertising

Every business has their own overhead expenses and few are exactly the same. Typically, the expenses listed under overheads tend to be the same over the range of time your Profit and Loss is reviewing. But watch them closely to spot the changes. They are the key to your Profit.

So we agree on this: profits are the difference between revenues (from sales) and expenses from COGS and overhead. Profit = Revenues – Expenses

To understand how well your company makes a profit, look closely at the types of expenses subtracted from the revenues. Ask if they are being recorded accurately. If so, are they expenses you can do without? To know the answer, you have to understand how they affect you.  So….there are three kinds:

They are the production related expenses, such as raw materials, direct labor, commissions, shipping, etc. On the P&L, they are listed as the “Cost of Goods Sold” (COGS) and are typically your biggest expense.  Taking most of your money, they are the key to your business so you can’t get rid of them, you can only minimize them (more on this in other posts).

Fixed expenses are constant. They do not vary with sales or production. They are the basic overhead costs of the company such as: utilities, insurance, postage, etc.  On the P&L, fixed expenses are listed under the heading, “Selling, General and Administrative” (SGA) and may contain several different categories.  Don’t get confused by the name (SGA) as it is just jargon for this type of expense.

Discretionary expenses are those which the you control in order to decrease or increase the reported profits. When looking at your P&L, the following expenses are the items you can change to create a greater profit or loss:

• Officers’ Salaries (including yours)
• Interest Expense
• Depreciation
• Rent

These items should not be changed lightly.  Talk to your accountant before you make any quick moves because it affects your taxes payable.  I know, I know. You don’t like paying taxes but the more profit you make, the more taxes you pay.  So keep looking at the profit!

Adjusting expenses like rent, compensation (salaries), interest, and depreciation may give you much more cash flow.  Once you have this cash flow, you can use it for growth or reward yourself and key employees. The choice is yours.

1. You can get rid of your rent payment by buying the building you are currently leasing. Cash flow can increase or decrease depending on the cost of the building.
2. If you are extremely profitable one year, you can accelerate depreciation.   This will reduce reported profits.
3. If you restructures existing financing or pay off a loan, your interest expense may be lower. This will increase your profit and cash flow. You can then get a new loan for a business expansion project, again changing your cash-flow and profit.
4. There is more than one way to compensate yourself and key employees.  They can dramatically affect your annual profit. Other types of  compensation include: dividends, travel and entertainment expenses,  and pension fund investments.These may not be taxed the same way as your salary. Ask your accountant about them!

There is hidden value in your P&L. You just have to know where to look for it and now you do!  Talk to your accountant and go over your financial statements. Don’t wait until tax time for this chat. Do it on a regular basis and look at your P&L at least on a monthly basis.  Call and speak with your accountant today!

On your team,

Mark

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