Strategic Pricing Model » Organizing Your Financial Statements

The Purpose Of Organizing Financial Statements

Financial statement formats can be found anywhere on the Internet. But all those examples don’t really illustrate how you should structure your financial statements. Look at the income statement below. Write some notes about what you see.

If you think this looks normal, pull out your financial statements! They might not be organized to be most effective in strategically pricing a product and in cutting costs.

Most companies are guilty of what The Strategic CFO calls “counting paperclips!” Many companies provide more detail on their overhead than operations. Why is that? Accountants feel they have more control over overhead!

[box] Aspiring Financial Leaders: Want to get to the next level? I’m guessing you do because you probably wouldn’t be here if you didn’t want to improve your skills or learn new skills to become a Controller or CFO. One thing that can help you get there is to stop counting paperclips. Take initiative and start providing more detail above the line. [/box]

Ask Yourself

How many line items do you have on the income statement for…

Revenue = ?

Cost of Sales = ?

SG & A Expenses = ?

Of the SG & A Expenses, do you have a balance less that $5,000?

If you find yourself with one revenue item, then one COGS item, and an entire page or more full of SG & A Expenses, you might be missing out on profits, might have mis-priced a product or worse. The Strategic CFO advises our clients to create a COGS line item for each revenue item. This will help you in strategically measuring your unit economics to calculate the profitability of that product at a given price point.

Reducing Overhead

A lot of financial leaders tend to count pennies and build up their overhead because they don’t want to assign it to the products. Allocate those “overhead” items above the gross margin to COGS.

Format

Look at the format you applied to your unit economics. Then you need to apply that same format in your financial statements. You will not be able to compare your financial statements to your unit economics effectively if you are not consistent.

How To Do This

Because most companies provide more detail on their overhead than operations, their financial statements should be improved by:

  • Increasing the number of activities accounted for in the revenue and cost of sales sections of the income statement
  • Organizing the revenue along strategic lines (products geographic areas, sources)
  • Matching the cost of sales to revenue so that margins can be calculated by segment
  • Reducing the overhead accounts to a minimum; avoid adding new accounts needlessly

An effective strategy is to organize your financial statements in the same manner as you bid jobs or price products. You would group expense accounts in the same manner for calculating gross margins as you do when setting prices. Monthly, you would need to check your gross margins per the financial statements in comparison to the targeted gross margins when you set prices. Investigate any variances!

Often what happens is that certain direct costs are included in the overhead versus the cost of sales thus making any comparisons to the pricing model impossible.

You might recall the financial statement provided to you in Purpose (see below for reference.)

As you can see the expenses are an endless list of accounts that should be restructured. Using the tips supplied above, this financial statement below is one that will help management make better decisions that will have a positive effect on the bottom line.

 How Do I Analyze Expenses?

Start with the big picture then “drill down”. Align your costs with the target economics of your company.

When the volume drops, you have to reduce the costs.

Compare summary financial statements to expected economics.

Perform Flux Analysis on detailed financial statements.

Target the largest dollar line items to review first.

In analyzing expenses, it is useful to sort the expenses (specifically general and administrative expenses) by amount. Target the largest expenses for review. You can often find “low hanging fruit” by focusing you effort on one or two expense categories.

Finally, look for relationships to volume (% of sales).

If you don’t know you targeted economics, then how do you know what costs to cut?