Accounting and Finance for Your Small Business Second Edition_13

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Nội dung Text: Accounting and Finance for Your Small Business Second Edition_13

Evaluating the Operations of the Business SECTION III Profit Center Reporting The last section was concerned primarily with reporting on opera- tional issues, such as machine utilization and scrap rates. However, these are of no import if a company cannot consistently create a profit or spin off enough cash flow to keep those operations run- ning. In this section, we review the concept of profit centers, and how one should report their results. Every company creates and issues an income statement that reveals the financial performance of the entire company. For smaller organizations that deal with just a single line of business, such as a plumbing service company, this is sufficient. However, if there are several lines of business, such as a plumbing service group, a plumbing hardware store, and an air conditioning repair staff, then the revenues and costs of each one should be recorded separately, so that management can see if some areas are less profitable than others. An example of this report is shown in Figure 9.8, where we list a separate income statement for each profit center, which sum- marizes into the summary-level income statement for the entire company, as shown at the far right side of the report. Also in the report is a separate column for corporate overhead. These are costs that cannot be specifically allocated to a profit center. The basic rule for making the allocation determination is whether an overhead cost will disappear if a profit center is eliminated; if not, then do not allocate the overhead cost to the profit center. Also, there is an interest expense charged to each profit center, based on the amount of fixed assets and working capital that each one uses. Finally, after the profit figures at the bottom of the report, we add back the depreciation expense for each profit center (since this is a noncash expense), which yields the actual cash inflow or outflow to or from each profit center. The report reveals that the plumbing hardware store is making very little money, partially because of the interest expense charged to it that covers the cost of funds for the store facility and inventory (as pointed out by the arrows in the figure). Both service groups, having no significant assets, have a much lower interest expense and so earn a larger profit. Based on this analysis, it is evident that the hardware store is a drag on the over- all corporate earnings percentage. 282
Reporting CHAPTER 9 FIGURE 9.8 Profit Center Income Statement (000s) Air Summary Plumbing Plumbing Conditioning Corporate Income Description Service Hardware Repair Overhead Statement Revenue $1,400 $1,750 $972 $0 $4,122 Direct Expenses: Material 625 1,115 410 0 2,150 Direct Labor 450 250 350 0 1,050 Total Direct Cost 1,075 1,365 760 0 3,200 Total Direct Margin 325 385 212 0 922 Direct Margin Percentage 23% 22% 22% 0% 22% Overhead Allocation 14 57 14 375 460 −375 Gross Margin 311 328 198 462 Gross Margin Percentage 22% 19% 20% — 11% General & Administrative 25 85 25 175 310 Interest Expense 42 193 29 0 264 −550 −112 Net Profit (Loss) 244 50 144 −3% Net Profit Percentage 17% 3% 15% — + Depreciation Expense 21 81 21 37 159 −513 Cash Inflow (Outflow) 264 131 165 47 Capital Usage: Working Capital 325 1,578 175 0 2,078 Fixed Assets 145 565 145 258 1,113 Total Capital Usage 470 2,143 320 258 3,191 To create a profit center analysis, the accounting staff must track billings and expenses by specific profit center, rather than recording them all in a single set of account numbers, which is a slightly more complicated accounting transaction. Also, all assets should be recorded in accounts that are specifically assigned to profit centers, so that interest expenses can be charged based on these amounts. The most difficult item to track is working capital for each profit 283
Evaluating the Operations of the Business SECTION III center, because this requires the identification of all accounts receiv- able, inventory, and accounts payable by profit center. To record working capital accurately, it may be necessary to either maintain a separate set of accounting records for each profit center or manu- ally compile this information whenever the accounting staff creates a profit center financial statement. Given the amount of detailed information that results from this report, the added work is well worth the effort. Customer Margin Reporting If a company creates an income statement report by profit center and the management group still feels that it does not have enough information, the next logical step is to create a customer margin matrix, because it reveals an additional level of detail by showing profits by customer for each profit center. This method results in a matrix, as shown in Figure 9.9, that segregates all company cus- tomers into one of four quadrants on a profitability and volume chart. The quadrant in the lower left corner contains those cus- tomers that are marginally profitable and also have minimal sales volume. The quadrant in the lower right corner is the worst one, for it contains those customers with low profit margins and high volume (e.g., the company is expending much effort for little result). The company’s objective for the customers located in these first two quadrants is to either eliminate them or raise their prices to improve profits. The quadrant in the upper left corner contains customers with high margins but low sales volume. The objective here is to improve their purchasing volume. The final quadrant, which is in the upper right corner, is for high-volume, high-profit customers, and contains all the prized customers that a company absolutely does not want to lose. This report format is extremely revealing in terms of which customers should be dropped and which given special treatment, and, with some deft customer man- agement, can result in a much more profitable mix of customers. The cutoff figures for margin and volume, as noted in the example, will change depending on the business. The dividing line for high and low margins may not be 25 percent, as shown in the example, nor may the volume demarcation be $100,000. A company can set 284
Reporting CHAPTER 9 FIGURE 9.9 Customer Margin Matrix Margin No. of Customers = 8 No. of Customers = 5 Total Sales = $450K Total Sales = $800K Average Margin = 41% Average Margin = 38% Margin Margin All Day Fitness 52% Central City Gym 41% Better Body Fitness 38% Fitter Bodies Co. 47% Body Builder Warehouse 41% Nationwide Gyms 33% Custom Bodies Co. 43% Powerbuilder Plus 35% Fitness Designs 45% Runner’s Palace 34% Jump Higher Aerobics 39% Weights by Design 62% Weights Warehouse 29% 25% No. of Customers = 7 No. of Customers = 4 Total Sales = $325K Total Sales = $1,417K Average Margin = 1% Average Margin = 11% Margin Margin All Round Fitness –3% Barbells Plus 13% Dumbells Only 0% Fitness Distribution Co. 7% Fit by Night Inc. 3% Kids Gyms and Day Care 11% Ladies Workout Co. 7% Southern Fitness 10% Midwest Fitness 5% Powerhouse Bodies 0% Pumped Workouts Co. –14% $100K Revenue Volume its own boundaries with different figures. Also, the margins on which this information is based can be calculated in several ways. One is to use direct costing (i.e., price minus direct labor and mate- rial costs), because of its simplicity. Alternatively, the margin calcu- lation can include fully burdened costs, although this approach may result in overhead costs being assigned that have little real basis in fact. Accordingly, if margins are to include overhead costs, use activity-based costing to ensure that there is a justifiable reason for assigning costs to a customer. With the operations reports, profit center analysis, and cus- tomer margin matrix, a management team will have a plethora of information on which to base its decisions to improve company profitability. 285
Evaluating the Operations of the Business SECTION III Summary Businesses have varying reporting responsibilities to federal, state, and local jurisdictions. They have other external reporting require- ments to creditors and investors. Finally, they have internal report- ing functions used for planning and control. The federal reporting requirements include employment reports on wage-earning employees, tax reports, and Social Security taxes. Employers pay unemployment taxes for their employees. The fed- eral government has arranged for banks and federal depositories to receive taxes collected from employees and those paid by the employer. The employer withholds federal income tax and Social Security taxes and pays those into the federal depository pursuant to IRS guidelines. Annually, the IRS requires employers to report to their employees the wages and taxes paid and withheld. Depending on the form of the business organization, there are various reporting requirements for federal tax liabilities. Sole pro- prietorships, S corporations, and partnerships pay income taxes for the business entity. However, S corporations and partnerships file information returns. Corporations are taxed as a separate legal entity. Other reporting requirements arise out of the nature of the business. For example, dealers in firearms are strictly licensed and regulated by the United States Treasury Department. Other busi- nesses are regulated as to rates, charges, and services offered. Utilities, transportation companies, banks, and other such indus- tries are closely regulated. Some, because of the dangers associated with working conditions, are closely scrutinized. Coal mining, toxic chemical companies, and airlines are just a few such activities. State governments also regulate and tax many businesses and activities. States generally tax the real property of businesses and the structures attached to the property through their ad valorem taxing authority. A business’s equipment, fixtures, appliances, and inventories might be taxed using tangible personal property taxes. Intangible items of ownership, such as stocks, bonds, and notes, are taxed through intangible personal property taxes. In some cases, sales and purchases made in other states are taxed. Some products, 286
Reporting CHAPTER 9 such as groceries, medicines, and telephone services, are exempt in some states. Local governments may impose taxes, licensing requirements, and zoning restrictions on the operations of some businesses. Some county or city governments may have franchise requirements for the provision of services; these may be exclusive rights to provide services, such as cable television. Creditors have or seek certain information to ensure the like- lihood of payment. Balance sheets, income statements, and state- ments of cash flow may be prepared and distributed. Investors, likewise, are concerned with these reports. Finally, businesses have internal reporting requirements for plan- ning and control. These needs vary with the size and type of busi- ness and with the style of management used. 287
Index B A Bad debt method, 233 Accounts payable Balanced scorecard, 204–207 Controls, 90 Balloon loans, 169 Number of days sales in, Bank 164–165 Financing, 167 Reduction of, 145 Reconciliations, 83–84 Accounts receivable Banker’s acceptance, 107 Controls, 85–86 Boiler and machinery insur- Liquidity, 184–186 ance, 245–246 Number of days sales in, Bond financing, 170, 171 164 Breakeven analysis, 69, Reduction of, 144–145 222–229 Acid test ratio, 184 Brokerage house financing, Ad valorem tax, 266 167 Advances, non-payment of, Budget 80 Capital, 33–34 Agency securities, 106–107 Cash flow, 112–132 Annuity definition, 40 Definition, 3–4 Arithmetic mean, 210 Direct labor, 29–30 Asset Facilities, 33 Theft, 80 General and administrative, Turnover ratio, 192 32 Automation, budgeting, 7 289
Index Forecast, 34–35, 160–161 Budget (Continued) Fraud, 79 Improvements, 6–8 Investment factors, 104–105 Ineffectiveness, signs of, 4–6 Management, 113–126 Interlocking system of, Certificate of deposit, 107–108 25–35 Charter tax, 267 Inventory, 29 Claim administration, Overhead, 30–31 242–243 Marketing, 32 Coefficient of variation, 212 Production, 28 Collateral, 173 Purchasing, 29 Commercial paper, 107, 170 R&D, 28 Commercial property insur- Reports, 23, 24 ance, 246 Revenue, 26 Common stock, see Stock Tracking and maintenance, Compensation planning, 236 21–25 Comprehensive auto insur- Updates, 7, 35–36 ance, 246 Business interruption insur- Concentration banking, 109 ance, 246 Control systems Accounts payable, 90 C Accounts receivable, 85–86 Cash, 81–84 Cost of goods sold, 93–94 Capacity utilization, 215–222 Current liability, 90–91 Capital Elimination of, 97–99 Asset pricing model, 51 Fixed assets, 88–89 Budgeting, 7, 33–34, 39–75 General, 96–97 Cost of, 49–54 Inventory, 86–88 Captive insurance company, Investment, 84–85 249 Need for, 77–79 Cash Notes payable, 91–92 Controls, 81–84 Payroll, 95–96 Disbursement, 127–130 Prepaid expenses, 88 Flow, analysis of, 108–112 Revenue, 92–93 Flow, budgeting, 112–132 Travel and entertainment Flow, discounted, 58–59 expense, 94–95 Flow, example of, 133–142 Controlled disbursement, 110 Flow worksheet, 54–57 290
Index Present value, 40 Corporation tax return, Present value index, 41 259–260 Delayed shipment report, Cost 276 Accumulation of, 11–25 Depreciation Center, 10–11 Estimates, 65 Fixed, 12–14 Rapid, 235 Historical, 17–19 Direct labor budget, 29–30 Of capital, 49–54 Directors and officers insur- Of goods sold controls, ance, 246 93–94 Discounted cash flow, 58–59 Variable, 14–16 Disbursement, controlled, 110 Mixed, 16–17 Distribution of outcomes, 62 Coverage ratios, 188–189 Dividend restrictions, 172 Creditors, 268–269 Documentary stamp tax, 266 Current liability controls, 90–91 Current ratio, 163 E Customer margin matrix, 285 Earning power percentage, 192 D Economic development authority loans, 170 Employee stock ownership, Debt 236–237 Convertible, 152–153 Environmental Protection Cost of, 50 Agency, 262 Description of, 149–150 Excise tax, 267 Ratios, 187–188 Expense account fraud, 80 Deferred installment sales, 232–233 Definitions F Annuity, 40 Budgeting, 3–4 Facilities, 33 Capital budgeting, 39 Federal Energy Regulatory Internal rate of return, 41 Commission, 262 Net present value, 40 Feedback loops, 5 Payback period, 40 291
Index I Federal employer identifica- tion number, 255–256 Federal unemployment tax, I-9 form, 256 256 Income tax Fidelity bond, 246–247 Estimated, 261 Financial statements Return, 258–261 Linkage to budget, 34 Industrial revenue bonds, Misrepresentation, 80 170–171 Profit center, 283 Inflation estimates, 57–58 Financing Inland marine insurance, 247 Debt, 149–150 Insurance Intermediate, 150–152 Broker, 241–242 Lease, 168 Claims administration, Long-term, 152 250–252 Mortgage, 168–169 Company financing, 167 New business, 143–144 Company, captive, 249 Secured loan, 150–152 Coverage, 245–248 Sources of, 167–168 Unemployment, 262–263 Stock, 153–160 Interest Fixed asset Account, 105–106 Controls, 88–89 Expense, 66 Theft, 80 Rate limitation clause, 174 Fixed costs, 12–14 Internal rate of return Forecast, cash, 34–35, Definition, 41 160–161 Example, 70–72 Fraud, types of, 79–81 Inventory Budget, 29 Controls, 86–88 G Loans, 152 Number of days supply, 165 Gasoline tax, 268 Obsolete, 87–88 General and administrative Reduction of, 145 budget, 32 Theft, 80 General liability insurance, Investment 247 Banker financing, 167 Government loans, 168 Center, 11 Grace period, 174–175 Controls, 84–85 Gross profit margin, 190 Factors, 104–105 292
Index Secured, 150–152 Fraud, 79 Small Business Tax credits, 235 Administration, 170 Lockbox K Controls, 82 Description, 109 Kickbacks, supplier, 81 M L Machine utilization report, 277 Lease Marketing budget, 32 Financing, 168 Median, 210 Tax benefits, 236 Mixed costs, 16–17 Lease-purchase decision, 65, Mortgage financing, 168–169 146–147 Mutual insurance company, Letters of credit, 165–166 249 Leverage-financed loans, 169–170 Life cycle, 42 N Liquidity Investment, 104 Net present value definition, Reduction of, 113 40 Lloyds of London, 249 Net working capital, 162–163 Loan Notes payable controls, 91–92 Balloon, 169 Collateral on, 172 Commercial, 168 O Conversion agreement, 174 Economic development Occupational Safety and authority, 170 Health Administration, Government, 168 262 Grace period, 174 Ocean marine and air cargo How to obtain, 160–166 insurance, 247–248 Inventory, 152 Operating profit rate of return, Leverage-financed, 169–170 191 Prepayment penalty, 174 Operating ratios, 196–202 Restrictions on, 171–173 293
Index R Outsourcing of operations, 147 Overhead budget, 30–31 Overtime, 274 R&D Budget, 28 Financing arrangements, P 171 Ratio Partnerships, 147–148, Acid test, 184 258–259 Analysis, 180–182 Payback period definition, 40 Asset turnover, 192 Payroll controls, 95–96 Coverage, 188–189 Personal property tax, Current, 163, 182–184 266–267 Debt to net worth, 163–164, Petty cash controls, 81–84 187 Policies, risk management, 238 Debt to total capital, Preferred stock, see Stock 187–188 Prepaid expense controls, 88 Management, 202–204 Present value Operating, 196–202 Definition, 40 Profitability, 190–191 Index, 40 Reports Table, 61, 72 Budgeted versus annual Product costs, 23 Bailout, 68–69 Capacity utilization, 219 Discontinuance, 66–68 Comparison of budget to Life cycle, 42 actual, 24 Production Customer margin matrix, Budget, 28 285 Schedule, 20 Errors report, 281 Profit Delayed shipment, 276 Center, 11, 282–284 Lost customers, 279 Projections, 162 Machine utilization, 277 Profitability ratios, 190–191 Management, 269–285 Purchasing budget, 29 Overtime, 274 Risk management, 245 Statistics, 272 Q Responsibility Accounting, 9–10 Quick ratio, 163 Centers, 10–11 294
Index Subscriptions, 159–160 Revenue Swap for expenses, Budget, 26 158–159 Center, 11 Warrants, 159 Controls, 92–93 Supplier kickbacks, 81 Forecasting, 19–21 Risk Analysis, 209–215 T Investment, 104 Management, 237–245 Taxable entity, 234–235 Return relationship, 48–49 Tax Ad valorem, 266 S Charter tax, 267 Documentary stamp, 266 Excise, 267 S corporation, 261 Filings, 257–258 Sales tax, 263–265 Gasoline, 268 Sales, deferred installment Income, 258–261 method, 232–233 Personal property, 266–267 Securities Sales and use, 263–264 Agency, 106–107 Tax liability Treasury, 106 Control of, 232–237 Self-insurance, 249–250 Deposit of, 257 Signature plates, 82 Individual, 265 Small Business Administration Sales and use, 263–265 loans, 170 State, 234 Social security tax, 256 Travel and entertainment Sole proprietor ship tax expense controls, 94–95 return, 258 Treasury securities, 106 Split-dollar life insurance, 248 Turnover ratio, asset, 192 Standard deviation, 211–212 Statistics report, 272–273 Stock U Common, 153–156 Company, 249 Unemployment insurance, Private placement of, 262–263 157–158 Use tax, 263–265 Preferred, 156–157 Utilization, capacity, 215–222 Rate of return on, 191 295
Index V Worksheet Capital budgeting cash flow, 54–57 Variable, 14–16 Capital budgeting evalua- Variance analysis, 22 tion, 59–62 Venture capitalist financing, 168 Y W Yield, investment, 104 W-4 form, 256 Workers’ compensation insur- Z ance, 248 Working capital Zero balance account, 109–110 Net, 162–163 Zoning restrictions, 267 Zero, 144–148 296