One of the most important jobs a business owner has on his or her plate, besides sales, marketing, financing, accounting, production, quality-control, and HR, is collecting and analyzing the immense amount of data your business generates. Collecting data is the easy part. Analyzing it is harder.
Profit & Loss (P&L) Statement
It all starts with determining what numbers are important to the overall health of the company. I used to think that the most important number was the net profit shown at the bottom of the Profit P&L statement. But then I learned about all the shortcomings of a P&L statement, at least in a manufacturing business like mine, and started treating it with a more nuanced approach.
The P&L statement simply shows the total monetary inflows and outflows over a specific period of time. That is it. It’s up to the user to determine if the time period being analyzed is too long, too short, or just right. Before the correct duration is settled on, the numbers can paint all kinds of incorrect pictures.
For my business, with a sales cycle of 3-8 weeks, the P&L statement is best viewed on a quarterly basis. I have found that if I decrease the P&L’s duration to a month, then the delay between when we record the sale and when we pay for that job’s material and labor, tends to skew the monthly numbers. But if I draw the snapshot out to any period longer than a quarter, the numbers are less useful for short-term analysis.
Once the P&L statement has been created, I look at just four groups of numbers: 1.) Material, 2.) Labor, 3.) Expenses, and 4.) Net Profit. Each category is assigned a percentage of the total. My goal is to have material costs at 30% of sales, labor at 35%, and expenses at 15%, leaving a net profit goal of 20%.. To simplify record keeping, we record 100% of the sale when I send out the initial sales order.
The same goes for material. It’s all recorded in one lump sum when I receive the bill, even if the material is not going to be used for many more weeks. Most of our jobs are completed around the four week mark, so over-complicating record keeping in order to customize the P&L statement isn’t worth it.
Cash Flow Statement
I have to be honest about the cash flow statement. I have pretty much treated it as the P&L’s long forgotten cousin. While my father and I regularly analyze the P&L statement, I cannot remember when we ever looked at the cash flow statement together, something that we are going to change.
The cash flow statement is a snapshot of how cash moves through your company. The P&L statement shows sales and expenses, not where cash comes from or goes.
You want cash on hand to be as large as possible, and as many assets as necessary with as little long-term debt as possible. This shows that your company has the infrastructure necessary to produce a good or service without the crushing obligation of monthly lease or loan payment hanging over it’s head.
Also important are the receivables owed to us by clients, versus the payables we owe vendors. You don’t necessarily want the receivables number to be large, because that just means you have clients that owe you and aren’t paying. And you don’t want your payables to be large, because that means you purchased a bunch of inventory that will be sitting in your shop unused. In the next installment, I will discuss the metrics I track to analyze individual projects.
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