Making Sense of an Income Statement
Asking the right questions when reviewing a profit and loss statement will facilitate better decision making.
The mid-way point to 2018 is here, and it brings with it the running, printing and emailing of various reports like financial-based statements. Take, for example, the balance sheet and human resource reports detailing attendance or operational data, like Overall Equipment Effectiveness (OEE). Whether these reports are sought out or thrust upon mold builders, the information the reports contain can help mold shop owners, managers and operators to understand their business better and improve decision making.
One prominent example of these reports is the profit and loss report, which is also known as an income statement. Many mold builders look to this report to answer the question, How did we do? This question takes many forms, depending on who is asking. Many mold builders ask, Was there a profit or a loss? What was the material expenditure? What was the revenue in each department? How much was spent on overtime?
While these are all valid questions, none of them help mold builders make decisions. Mold builders need to ask different questions to facilitate decision making. Managers should ask questions like, What was our profit percentage compared to industry averages? What was my material expenditure this quarter compared to a year ago? How did departmental revenue compare to budget? What percentage of total payroll was overtime?
The primary difference with the latter questions is that mold builders are not viewing the report in a vacuum. Instead, they are comparing the data to the budget, actual performance in other periods or years, industry averages or other benchmarks. They also analyze the relationship of items. For example, a mold builder looks at each expenditure as a percentage of its parent expense group.
The goal is to uncover trends.
The Percentage Key
To ensure that the information is easily comparable, it is paramount that mold builders use percentages rather than actual dollar amounts. The most used income statement base component for profit and loss analysis is revenue, but mold builders should also examine subcategories of major expenses. This would simply make the revenue number 100 percent and each line item below it somewhere between 0–99 percent, depending on the amount.
Using percentages enables a comparison between departments, divisions and companies of different sizes. The performance of a department that spends $1,000 per month on steel versus one that spends $100,000 at first glance may seem impossible or even impractical. However, when a mold builder looks at that number as the percentage of raw material purchased or percentage of revenue that went toward steel, he or she can perform valuable analysis.
Dollar amounts can also be misleading. Being $10,000 over budget in payroll could be alarming upon first look. If revenue is $50,000 over budget during the same period though, it may not be a concern. In fact, if target payroll is 25 percent of revenue, this period would be viewed favorably at only 20 percent.
At a minimum, mold builders should always compare actual percentages to the period before the one that is being measured, the same period in the previous year and to the budget for the current period. If a mold builder obtains additional information from the state, industry or sector, it is advisable that he or she use this data as well. Mold builders can do deeper dives into the data by looking at several periods or years in a row.
Mold builders should also concentrate on the differences in the same item between periods or budgeted and actual totals. The goal is to uncover trends. This type of analysis allows for management by exception, which is a practice that focuses only on items that have a sizable variance. Management by exception is the practice of examining the financial and operational results of a business and only bringing issues to the attention of management if results represent substantial differences from the budgeted or expected amount. It is lean management at its finest!
Mold builders should also concentrate on the differences in the same item between periods or budgeted and actual totals. This type of analysis allows for management by exception, which is a practice that focuses only on items that have a sizable variance. It is lean management at its finest!
It is important for mold builders to investigate the cause thoroughly when significant trends, positive or negative, are discovered. Mold builders can do this by reviewing additional data, performing a visual inspection and asking questions. For example, during an OEE analysis, a vertical machining center’s performance is shown to be substantially lagging historical output. In this case, it may be necessary to review attendance reports, training records and preventive maintenance logs and interview employees before a solution is determined.
Once the mold builder determines a solution, he or she should devise and implement an action plan that contains a measurable and timely target outcome. In future periods, the success of the strategy will be evident by what happens to the data. If the shop does not achieve the desired result, the action plan may not be sufficient, or it may not have uncovered the actual problem. When the mold builder applies the right solution to the right problem, the data will reflect it.
While these reports can be extremely valuable management tools, they can have limitations as well. Information must be accurate and credible for it to be useful. Systems must be in place to make certain the mold builders are not using data that has been corrupted or misrepresented.
Another potential issue is that reports may conflict. A safety report could show an increase in accidents during a period when employee attendance improved. This outcome is contrary to what the shop expects. Mold builders should always investigate these contradicting statistics down to the root cause of both the negative results (more accidents) and positive results (better attendance).
The mold building industry has access to more data now than at any point in history. If you look at your data differently, it can drastically improve your decision making and increase your shop’s chances of success. Hopefully, this column has encouraged you to uncrumple your recently discarded profit and loss report and give it another look. In August, I will review pricing. Are you confident that you are charging the right amount for your molds? Until then, happy analyzing!
About the Contributor
Charlie Daniels is a certified management accountant and the chief financial officer for Wepco Plastics Inc.
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