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Income Statement Changes Needed

Crouser Report OnLine March 9, 1996

Transmitted from Sarasota, Florida Tom Crouser presents Power Pricing in NEW ORLEANS on Saturday, March 23rd for the Gulf Coast Association of Quick Printers. For meeting information, message Gator4Fun@aol.com. Also, we will be soon visiting Pennsylvania, Florida, Iowa, California, Michigan, Tennessee, Colorado and North Carolina. Two on-site dates are available in the south in April along with one in Colorado in May. Other appointments are being accepted for September and later. Reply to me for more details. Dear Friends. . .

Spring is just about here, so my thoughts turn to spring cleaning. I propose we clean up the information we receive from our financial statements. And, since I have spent the winter classifying the balance sheet, let s start this spring by throwing out our current income statement. Why? Most income statements are mishmashes of misinformation. They obfuscate rather than clarify.

Let s start with the basics. The income statement is one of the four parts to a financial statement (others being attest letter, balance sheet, and statement of changes). The formula for the income statement is Income - Expenses = Net Income. Now, among accounting theorists, the income statement should be organized in order to give the user usable information.

The first order of business is to separate variable expenses from fixed expenses. Why? So you can see where the problems are. How do you do that? Analyze the fixed and variable expenses. As a printer, the following three things are most important to you:

  1. Direct materials as a percentage of sales.
  2. Total wages (benefits, taxes, etc.) as an absolute $ amount and a percent of sales.
  3. Total overhead (rent, utilities, etc.) as a absolute $ amount and as a percent of sales.
Why are these most important to you? Because you can easily analyze this information and compare it to industry standards. Generally, I use the starting point of 100% Income - 25% direct materials - 25% labor - 25% overhead = 25% income before owner s compensation. Variances from these standards then can easily be analyzed.

What would it tell you if your income statement was 25% direct materials; 40% wages; and 40% overhead? You probably have a sales activity problem. You have the capacity, you just don t have the sales. If you have a 40% cost of direct materials; 35% wages and 30% overhead may mean you have a pricing problem. There are other possibilities, but this level of analysis is your starting place.

But, you say, my income statement is not set up to show me that information easily and in order to see (analyze) this, I would have to spend hours fiddling with it. Ah Ha! My point, exactly. During on-site visitations, I spend time reconstructing financials so the client and I can see what is going on. Think of it. Why? Because the income statement is not set up to allow ease of analysis. Why isn t it?

Here s Why
There are different types of income statement formats depending upon what is important to the business. Accountants are exposed to a number of different formats in school. Lacking any direction from the printer, they choose one, usually a manufacturing format because we, after all, make stuff.

A manufacturing format generally looks like this: Income - Cost of Goods Sold (Direct Materials + Direct Labor and associated costs + sometimes manufacturing equipment depreciation) = Gross Income - Sales Expenses - General and Administrative Expenses (including Indirect Labor and other Depreciation) = Net Income. The principle behind this statement is to move variable expenses (direct material, labor, etc.) into one group and fixed expenses (rent) into another. This allows the user better budget information for, the theory goes, as sales are reduced, the cost of goods sold can be trimmed.

There is nothing wrong with the manufacturing format, mind you. It is, however, in my opinion, not preferable for small press shops. Why? Labor is not a variable expense in a small press shop. Now, I don t challenge the fact that it varies from week to week. I do challenge the notion that if there is nothing to do, we would send our press operator home. That s the best way in the world to loose press operators.

Neither am I saying that all printing companies should avoid the manufacturing format. The Printing Industries of America uses a manufacturing based chart of accounts which allows the user to easily use value added principles to manage their business. I am saying that a print shop with less than $1 million in sales (most of us reading this) would be better served using a simplier income statement which highlights important issues to the user.

My Solution
So, I would modify the accounting equation of Income - Expenses = Net Income to Income - Direct Materials - Labor - Overhead = Income Before Owner s Compensation - Owner s Compensation (officer s salary) = Net Income.

Using this layout, the reader can easily see total direct materials as a percentage of sales as well as keep easy tabs on labor and overhead. This allows for easier budgeting as well as an earlier warning system since problems are more apparent earlier and easier..

Objections
My income statement is already set up with a long history of amounts and we would lose comparability with the previous year if I made a change. This is probably the biggest objection. However, I argue that comparability to the prior year generally is less important than knowing where you are going today. Actually, many accounting programs will allow you to set up your prior years activities if you wish, but I don t recommend it for it usually is more work than it is worth. Actually, you will get the biggest complaint from your accountant for it will require them to do most of the work. But, fixing your most important information system in the company is worth it.

Other Issues
While we are on income statements, let me touch on a variety of issues surrounding the document.

Departmentalization.
Most folks who departmentalize, do so much too early within the development of their business and end up chasing minutia. A department is one inwhich you can truly assign direct materials, labor and overhead and, if you eliminated the department, you would eliminate the cost. Otherwise, you have a cost center where you can generally assign direct costs but other costs are so integrated with other centers that all costs are not easily identifiable. For instance, many develop a bindery department and go to great lengths to separate their financial information when there isn t anyone assigned full time to the bindery. Better and cheaper information can be had, in most cases, by identifying bindery sales and bindery cost of direct materials. Same is true of brokered sales and brokered costs.

Allocations:
In cases where costs are not easily identified, allocations must be used. An allocation is an arbitrary assignment of costs by management. Allocations are generally costs which do not go away if the activity stops. Therefore, they are not direct costs and are not controllable by the person heading the department being charged. This is the epitome of management by visible numbers. Westinghouse allocating corporate overhead to a manufacturing department. One printer allocated his vacation expense to the Janitorial Department and wanted me to tell him why the janitor wasn t pulling his weight. Not all allocations are bad, but, generally I see allocations being used long before they are necessary resulting in minutia management.

Different Locations:
Now here is a true department. Open a shop on the other side of town and you can generally well define the sales, direct materials, labor and overhead of that store. Shut down the store and the sales and costs go away. But what do you do with overhead back at the first store which benefit the second store such as officer s salaries and the Porsche delivery truck? I tend to look at it as we do allocations. Would the overhead truly go away if you closed the second store? If so, charge it to the store. If, however, you are holding the store responsible for part of your Hawaiian vacation, you are doing it a disservice. Budget the second store for a contribution. Sales - Direct Materials - Store Labor - Store Overhead = Contribution. Then hold the store manager responsible for meeting the contribution budget. Disregard whether you take the contribution and spend it on a vacation, your salary or more equipment.

Sales Between Stores:
One of the most frequently abused privileges is the division of income between the store who sells the job and the store which produces the job. Generally, you will find an allocation of income in this situation about 25% to the selling store and 75% to the producing store. I feel this is a minimal markup (buy for $1 and sell for $1.33). Now, my question in these situations is, would the owner enter into an arm s length transaction with such a small margin? Usually the answer is no. Items I see in shops carry a 40% to 50% gross margin (selling price - cost of item = gross margin). So, if most of us would not deal with an outside source for such a low markup, why do we force the selling store to accept such a low margin? Hummm. Has a great impact on which store makes the money.

Accounting Styles
Actually, accounting styles have changed over the years. For instance, an older style is one inwhich interest expense is considered an extraordinary expense and is featured below operating income. Why? Well, interest was not considered until recent decades as being a regular expense of business. Those coming along later accepted interest as a fact of life and is included in overhead.

I have seen during the past ten years a couple of other changes as a sign of the times. Cleaning, Trash expenses have been expanded to include Cleaning, Trash and Waste Disposal. Also, ten years ago, security expense was never seen, but is prevalent today.

Performance Group Forming In Chicago
We will be forming a Performance Group of Printers in Chicago this year to add to our existing groups in Pittsburgh and Orlando. A Performance Group is a group of non-competing printers who agree to work closely with us in increasing their performance. Included are on-site evaluations, visitations and group meetings and other tools for the owner.

Here s what one of our participants said recently, In talking about support available from franchises, none of your responders mentioned one option - Tom Crouser! Most of the things your prospective franchisee is looking for are benefits gained by joining one of your performance groups (although I don t think your name recognition helps with our customers).

You, Pamela and the other members of our performance group have helped us to hire and train people, to get our accounting in order (some day it will happen), to buy effectively, and much of the other services he is looking for. The networking opportunities in a performance group are tremendous, and I know the seven other printers in the group are more than willing to help me out with advice. The performance group system isn t cheap, but it s a bargain compared to franchises!

TRAVELOG: I will present Power Pricing March 23rd to the Gulf Coast Association of Quick Printers in New Orleans. In March, we will be doing client work in Florida, Iowa, Louisiana and Wisconsin. In April, we will be in Tennessee, Kentucky, Michigan and North Carolina among other places.

CLIENT CONFERENCES: We have scheduled our first Production Manager s Conference for June 13-15, 1996 and our first Sales Manager s Conference for August 1-3, 1996. Both conferences will be held in Charleston, West Virginia and are open to current clients.

ON-SITE VISITATIONS: We always try to book our on-site visitations along with other clients in the same area, where available. Currently, there are some openings in our upcoming California, Colorado, and Texas. Please contact Pamela Crouser at (304) 342-5100 for more information.

Happy Trails.... Tom Crouser

P.S. Murphy s Law:
In order to get a loan you must prove you don t need it.

Another Murphy s Law: If everything seems to be going well, you have obviously overlooked something.

We exist to serve the marketplace. The better we do that, the more profits we will make. Steven Martin.

Take care of your customers and take care of your people, and the market will take care of you. John McConnell.

BACK ISSUES May Be Found at the National Association of Quick Printer s America On Line Site (keyword: NAQP, publications, Crouser Report) or on the internet at the PrintUSA web site (http://printusa.com/articles/crouser.htm) or on PrinterNet (modem: 910.767.2622). Hey, do we get around or what?
Crouser & Associates - Helping Printers Prosper Since 1985

Crouser & Associates Performance Group program includes two on-site evaluations by Tom Crouser each year along with two group meetings. Management training is held during the group meetings along with participation in a meeting with non-competing printers. Join others who have decided to run their business instead of the business running them. Reply to by Email to Tom Crouser for more detailed information or call Clark Workman at (304) 342-5100. Or fax (304) 342-5187 or contact crouser@ibm.net.

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Date inserted: Tuesday, March 12, 1996 4:16:39