Developing P&L Reports to Improve Visibility

Transcription

1 Developing P&L Reports to Improve Visibility a publication by and

2 Introduction Financial management systems are designed to measure and report business performance, but sadly, most systems fail to add value. Evidence of failure arises when one sees: A plethora of detailed, system generated reports that have varying levels of adoption across the organization Requests of finance for further ad hoc analysis before management can make important decisions Slow reaction time to operational, competitive or strategic issues as they arise An inability to pinpoint performance issues using management information Financial management systems should deemphasize information and instead focus on their true intended purpose, which is decision making. A strong management report should lead a reader to only one of two possible outcomes: 1. Confirmation that the business is tracking to plan and no changes in tactics or strategies are required at this time. 2. Identify that something is not going according to plan and that a potential change in tactics or strategies is required to capture a new opportunity or correct a problem. When designing a management report, and in particular the all-important profit and loss statement, the decision-making needs of the users are paramount. The availability of information is a secondary consideration. When user needs drive the design, the result is a management report that helps users make timely and measured responses to changes in the business. If the report isn t actionable by users, it s not useful. Effective management reporting is about delivering the right information to the right people at the right time. David AJ Axson, Best Practices in Planning and Performance Management 2

3 A great profit and loss statement establishes a common language across the organization. It transcends departments and enables managers in different departments to understand and communicate their own performance within the broader context of the organization. While the profit and loss statement is primarily a numbersdriven statement, the numbers themselves don t often tell the whole story. Often there are particular events or contextual circumstances that must also be incorporated into the management report to round out visibility of performance issues. For instance, consider the loss of a key customer as an important event or perhaps the increase of competitive activity as important context. Context is also driven by expectation. Expectations are driven by peers, budgets, prior periods, etc. Understanding the actual result against different benchmarks is another key objective of the management report. Context is also enhanced when additional information and metrics are incorporated. For example, knowing the volume of sales transactions help bring context. Insight improves when context is provided. Management information must be reliable to be actionable. This requires development of controls and systems that enable and protect a single source of the truth as the basis for generating all management information. In this report, we are going to take a closer look each of these themes insight, visibility, and a single source of the truth and explore them further to establish best practices for designing a management profit and loss report. 3

4 Insight The management profit and loss statement needs to be an intuitive, easy-to-understand, and attention directing report to make it useful and actionable. The macrostructure of the report must address each of the following requirements: 1. Reflect the business model and the organization structure and accountability Every organization has their own unique business model, which may be composed of different business units, different product lines, different geographical operations, etc. The management profit and loss statement needs to report results and pivot around each of these different dimensions. The management report must also establish and reinforce accountability of specific managers. Whether it s a manager of a product channel or a general manager of a business unit, the revenues and costs reported should reflect those line items over which a manager has discretion and control. For corporate allocations or other items, these should be aggregated separately below the line, in other words, below the direct revenues and costs of the profit center. 2. Establish context Context is established by comparing results between different periods, to budgets, or to peers. Context establishes an expectation for results and makes actual results comparable. Contextual comparisons are often set up in the columns of the management profit and loss statement and may be configured as: Month over month or a trailing twelve month format to enable a trend analysis or better understanding of seasonality Quarterly results with actuals presented side-by-side with the comparative prior period, which is often used to report financial results to inventors Budget comparisons, which are a useful baseline to refer to based on previously agreed upon plans 4

5 3. Allow for the evaluation of strategy execution The management profit and loss statement is a key tool of performance management. When financial results vary from expectation, this report will highlight in sufficient detail where the variances are and enable management to initiate action. 4. Portray performance The profit and loss statement is the best report for aggregating the operating activity of the business and performance of management throughout the period. When supplemented with other nonfinancial information it helps users understand the areas of strengths and weaknesses in the business. Performance also should be considered beyond just the business unit or departmental level. Performance by customer, by channel, by product, or by supplier are often insightful dimensions of the management profit and loss statement that help the organization better understand performance and hone tactics. 5. Give a future outlook The profit and loss statement need not be only backward looking. Often, it can be supplemented with a forecast of activity for the rest of the year. In this way, the management report bridges the lessons learned with re-establishing a new expectation for future results. This can help management with re-aligning resource allocation or help the Board of Directors with capital allocation decisions, such a dividend declarations and capital investments. Where possible, leading indicators, which may be financial or nonfinancial in nature, should be identified and incorporated into the report. Examples of leading financial indicators might be marketing spends or research and development expenditures. Examples of leading non-financial indicators might be new store openings or order backlog. Top performing finance teams spend 17% less time on data gathering and 25% more time on analysis than typical functions. PWC: PuttingYour Business on the Front Foot Finance EffectivenessBenchmark Study

6 When taken collectively, the management profit and loss report, along with any supplemental schedules, will embody: 1. Relevance to the user 22. The trend 33. Comparisons against thresholds 44. Early alert of performance issues 55. Call to action in required areas 66. Forecast the impact of variances from plan 77. Provide additional information to supplement context and understanding These principles are illustrated in the following figure Company ABC Previous Month The Month Ahead Income Statement Oct 20X1Act Oct 20X1Bud Act vs Bud Oct 20X0Act Reference Nov 20X1For Nov 20X1Bud For vs Bud Fav (Unfav) <== Fav (Unfav) Sales Pounds 5,602 7,454 (1,852) 7,188 6,107 7,892 (1,785) Value added (pounds) 3,734 4,766 (1,032) 4,328 3,928 4,751 (823) Commodity (pounds) 1,868 2,688 (820) 2, ,179 3,141 (962) Net Sales $19,066 $32,475 ($13,409) $27,835 A $22,318 $32,772 ($10,454) Value Added 11,840 15,501 (3,661) 12,743 13,422 15,524 (2,102) Commodity 7,226 16,974 (9,748) 15,092 8,897 17,248 (8,351) Gross profit 1,107 2,822 (1,715) 823 B 2,231 2,845 (614) Value added 1,299 2,023 (724) 550 1,960 2,075 (115) Commodity (192) 799 (991) (500) GP % 6% 9% -3% 3% 10% 9% 1% Value added 11% 13% -2% 4% 15% 13% 1% Commodity -3% 5% -7% 2% 3% 4% -1% Commission income (73) (82) SGA 1,329 2, ,690 C 1,560 1, EBITDA (144) 901 (1,045) (649) 710 1,053 (343) EBITDA % -1% 3% 17% 0% 3% 4% 4% Depreciation Interest (122) 63 D (125) Income taxes (217) (317) Net income for the period ($293) $389 ($682) ($575) $206 $481 ($275) Notes on Previous Month Revenue shortfall due to lower sales of product XYZ A Sales to Customer MNO were lower than budget. Lower GP on lower sales as well as production issues due to higher scrap. B Lower salaries +223 and travel +55, advertising +200, lower incentive +135 and prof fees +56 C Higher interest rates +225bps vs PY. D 7 6 6

7 Visibility The visibility of the management profit and loss statement is determined by the more detailed design elements of the report itself. All financial systems are designed around collecting and aggregating mass quantities of data, but thoughtful considerations needs to be given on how this data should be summarized and presented to users. The micro-structure of the report must address each of the following requirements: 1. Setting up the rows to bring visibility to management issues The whole management profit and loss report hinges on the row descriptors chosen. Having a profit and loss report that scrolls for pages provides too much detail. Having a profit and loss report that aggregates all sales or expenses in a single or small number of rows equally obscures the visibility to the key issues. Thus, grouping and mapping the chart of accounts to a summary of revenue and expense accounts takes thought and consultation with stakeholders. Keep in mind a few guidelines: Having a financial management system that allows you to group and map your chart of accounts to the management profit and loss statement streamlines the preparation. Sales should be broken out into separate lines when there are different drivers. For instance, product sales likely have a different sales driver than after-sales service revenues. Expenses should be broken-out into categories based on how they are controlled and managed. For instance, salary costs are controlled through a staffing plan. Travel and entertainment expenses are controlled through policies and oversight. Ensure that each row has a descriptor that is easily understood. Avoid accounting or industry jargon. Ensure that reported numbers are neither too large so as to obscure what is included or too small to distract attention away from more important accounts. 7

8 2. Include and label important subtotals Every row should include a descriptor of some sort so that no one is confused by any numbers included in the report. For subtotals, these descriptors will often become key indicators that will emerge as the common language for describing performance. Keep in mind a few guidelines: If certain items have not been included, such as corporate allocations, ensure that the subtotal reflects the absence of these amounts for example, Operating income before corporate allocations. This ensures that no one will be confused between operating income at the consolidated level and operating income at a lower level of reporting. Common subtotals include: total sales, total expenses, gross profit and/or contribution margin, operating profit, and Earnings Before Interest Taxes Deprecation and Amortization (EBITDA). Set up financial ratios on the face of the statement to calculate such things as gross profit margin percentage, operating profit margin percentage, and EBITDA margin percentage. 3. If possible, include other non-financial metrics Separate rows should be set up at the top or the bottom of the profit and loss report to track other key non-financial metrics such as sales volume, average selling price, sales per square foot, cost per unit, number of defect, etc. These metrics help establish important context for the interpretation of the financial results. Keep in mind a few guidelines: Be judicious in selecting only a handful of metrics that truly drive performance it could be volume, price, number of sales people, operating availability, etc. Create ratios using non-financial and financial metrics to enhance comparability between periods For example, sales per employee, sales per square foot, utility costs per room occupied, etc. Make sure the non-financial information can be easily tracked and is reliable. Weigh the cost/benefit of gathering non-financial information. 8

9 4. Format your reports to highlight issues The management profit and loss statement needs to direct attention to enable management decision making. Keep in mind a few ideas: Include variance columns expressed in terms of dollars and percentages against the established expectation (budget and/or prior year). Use colors, visual icons, arrows, or sparklines to draw attention to accounts or variances that exceed threshold tolerances. Thresholds might be defined in terms of a dollar amount, a percentage amount, or even standard deviations. Make sure your numbers are clean and round. This means eliminating decimals and extra digits. Consider the users of the information and the level at which they consume the information. If they manage their business using thousands of dollars, then round to the nearest thousand. If they manage using millions, round to the nearest million. Fewer digits help improve the visibility of information and makes it easier to identify issues, discuss them, and retain for future reference. 5. Make it flexible, make it comparable When establishing the row structure of the management profit and loss report, consider the overall reporting structure across the organization. Ideally, one row structure will be applicable for all derivations of the management profit and loss statement, whether the report is run at a consolidated level, customer level, department level, business unit level, etc. Establishing a consistent look and feel to the report will enhance user adoption and understanding of the management profit and loss report and foster development of the common financial language across the entity. The row structure should be resilient enough to withstand changes in the business that arise from time-to-time relating to restructuring, new product lines, mergers, and acquisitions. 9

10 Single Source of Truth If the management profit and loss report is to become one of the major tools for management discussion and decision making, the report itself must have integrity. Unfortunately, many organizations struggle with this because there are gaps and inconsistencies in the underlying data. People and technology cannot deliver credible management reports without first establishing credible data to support it. The management profit and loss statement must tie with the rest of the financial system. While most cost center and profit center managers will not be exposed to the balance sheet, the finance function must take care to ensure that the management profit and loss reports in aggregate tie to the financial reporting system, which includes any below the line and offline adjustments for accounting purposes and various other corporate allocations that get posted in the accounting system. This becomes much more problematic when management reports are created outside of the financial system using spreadsheets or when business intelligence tools are being used to pull data from databases outside of the financial system. A benchmarking study by PWC found that only 30% of the study participants had formalized a strategy to align technology to the business needs and that 60% of the study s participants were still relying on manual spreadsheet manipulation for preparing management reports. Cloud-based financial management systems are emerging that greatly enhance management reporting and offer a number of key benefits. 10

11 Benefit #1: The reports are generated inside the financial management system which alleviates the possibility of certain transactions getting missed. Benefit #2: Once the reports are configured, they are available on demand. They can be circulated electronically; or by using cloud solutions, be accessed anywhere. Benefit #3: Many of these types of solutions allow for an easy pivot of different dimensions, which is to say you can look at the profit and loss report from the perspective of the business unit, by product line, by customer, geographic location, or department. Benefit #4: Many solutions allow users to drill into the details on their desktop screen so that they are able gain deeper insight into results beyond what is presented on the face of the report itself without the need to follow up with finance. As such, a cloud-based financial management system can not only help with establishing reliability, but will also help achieve the objectives of bringing greater visibility and insight. Conclusion The management profit and loss statement is a key management tool for every organization regardless of industry, size, or business model. Designing a great profit and loss report requires the finance function to develop a deep understanding of the users needs for such reports. Strong business acumen helps to organize the report in a way that helps managers make intuitive judgments. Having the right technology helps finance spend more time on generating insight and less time on generating reports and ensuring their accuracy. Businesses need proactive rather than just reactive management information to be able to keep on top of a fluid business environment and move quickly to seize opportunities. PWC: PuttingYour Business on the Front Foot Finance EffectivenessBenchmark Study

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