Topic: Accounting – Sales and Profit Analysis
Sales analysis is a very important component in improving the profit structure of a business. It is a vital accounting function at all levels of business whether small operators with under 1 million sales per year or large companies with multi-million dollar turnovers.
The importance of breaking your product sales and purchases into specific categories or product groups, for later gross profit analysis by each group could be considered a key element to a business’s success. It provides the only means of verifying the total gross profit achieved and also provides a platform to analyse where sales can be improved.
For example we could look at a furniture retailer. The product groups could be:
1. Broken up into areas of a house or office so the 1st split is found
2. The next areas would define each area of the home or office
3. The it is possible to further break-up an area into sub areas such as for a bedroom
a. Bedding
b. Cabinets
c. Bed Linen etc
Financial relevance is best demonstrated by example as shown in the following pages.
A further note of relevance for all business people is the need to be accounting literate. People place a great store on computer skills and internet skills whilst true business skills are consigned to the excuses ‘speak to my accountant’ or ‘I don’t have time for such things’. Accounting which is another word for statistical analysis of a business is the single most important skill you can have in business management.
You can sell… so what!
You have to buy or manufacture the product and account for the process with taxation, invoicing, stock control, cash flow control etc. When it comes to analysing where sales come from, what was sold, how much profit did we make, what stock do we have left, what do we need to buy or manufacture by when, what products should I emphasise in marketing etc then more questions are posed than answers.
A simple way to see the ultimate relevance of providing a detailed sales analysis would be assuming you wanted to sell your business, and would therefore be reflected in how you could sell your business based on one sales area, versus my business analysis using the twelve product groups used in my example. Which one of us would have more hope in attracting a buyer by showing that we:
1. understood our business
2. could be assured of maintaining our profit levels
3. explain the capacity for growth to justify our company’s potential
What do I mean?
Let us look at an example company that has a turnover of three million dollars ($3,000,000)
1. No attempt is made to separate the sales or costs
2. All sales go to a sales account in the general ledger
3. All costs go to a purchases account
4. Stock holdings are represented as applicable to a single sales figure
5. Gross profit (GP) is a single figure represented as a single percentage to sales
6. Let us say the GP is $810,000 or 27% of sales
7. Net profit is $240,000 or 8% of sales
This gross profit of 27% looks to be a reasonable return and could avoid critical analysis of the true business performance for the year. Many businesses whether they measure there turnover in the hundred’s of thousands or hundred’s of millions make the mistake of looking at the big picture only and not analysing what the actual result could and should have been. Hence 27% gross profit return that gives one a net profit of 8% may excite some people and give them a sense of achievement.
Christmas bonuses all round! Maybe not…
I was a financial controller of a group many years ago and the group made a 9% net profit return. The owner and board of directors of the company were very happy in a volatile market to achieve this return whilst I was despondent. I felt the result could have been at least 2% better and let my feelings be known. The owner was happy so I should be happy was the general theme, which I did not share.
I was able to prove that by analysing the sales break-up into a greater range of product groups that I could see where the profit drain had occurred and therefore where it could be fixed… to my satisfaction at least. This took a lot of work to extract manually and was soon fixed by altering the computer program and ledger allocations. The salient point here is why throw away profit when simple analysis by product group makes it easier to:
1. control profit to a degree not possible without product group analysis
2. improve your profit performance
3. place pressure on underperforming sales divisions and as in the case with my experience, completely remove a product line from the business’s sales portfolio
4. place pressure on suppliers of those products within the affected product groups
Incidentally the product group analysis was adopted for the group the following year and company profit was improved by the 2% … unfortunately I was not on an incentive bonus, but in later times when the market experienced a downturn the extra profit enabled us to carry extra staff who would otherwise have been laid off.
Let us now break down this company’s sales figures into a group of 12 sales categories:
Sales Group Sales Value Purchases $ Gross Profit GP % Rev GP% Revised GP
Group 1 520,000 380,000 140,000 26.92%
Group 2 250,000 180,000 70,000 28.00%
Group 3 200,000 142,000 58,000 29.00%
Group 4 380,000 295,000 85,000 22.37%
Group 5 400,000 260,000 140,000 35.00%
Group 6 300,000 195,000 105,000 35.00%
Group 7 240,000 162,000 78,000 32.50%
Group 8 90,000 64,000 26,000 28.89%
Group 9 120,000 80,000 40,000 33.33%
Group 10 150,000 135,000 15,000 10.00% 27.00% 40,500
Group 11 180,000 152,000 28,000 15.56% 27.00% 48,600
Group 12 170,000 145,000 25,000 14.71% 27.00% 45,900
3,000,000 2,190,000 810,000 27.00% 135,000
Expenses 570,000 19.00%
Net Profit 240,000 8.00% 67,000
Add to Net 67,000
Adjusted Net 307,000 10.23%
This analysis instantly highlights that Categories 10, 11 and 12 are a profit problem. You can also see by increasing the gross profit return for these three (3) sales areas to the general standard achieved of 27% we can expect an additional contribution to profit of $67,000. There may also be marketing opportunities to be undertaken to improve overall sales and profits by boosting better performing areas.
What if your business now had a turnover of one hundred million ($100,000,000)?
This improvement in product group performance is not always possible in all profit analysis areas but at least you are faced with the decision of:
1. Is the sales category (product items in this group) worth having?
2. Now that we know the profit position by product group we can:
a. Take steps to alter sales pricing
b. Rationalise the products in this group to the better performing products
c. Obtain better supplier pricing or different suppliers to improve either the pricing competitiveness or quality of product that affects sales
d. Market the product group to improve sales and/or profitability
3. Essentially you can make informed rather than ill-informed decisions
I would recommend setting up as many product groups as you think is reasonable to define your product range. Set the products to a default ledger code for sales and purchases so when a product is sold or purchased the ledger account allocation is automatic.
I would also caution in setting up product codes to define an alphabetic/numeric code so that staff can readily choose the correct code. Numbered product codes always create problems and imply a degree of knowledge. You coding should be based on inexperienced operators NEVER long term employees. The KISS (keep it simple stupid) method is always the one to use and should be as helpful in design so people make the correct choice every time and therefore you can rely on your figures generated by the software program to analyse sales and profit performances.
One of the greatest problems in accounting and using computer software programs is automatically using the results generated. When the allocations of charges are left to inexperienced staff then you can guarantee an ineffective profit analysis. When you define the allocation methods and then lock peoples modifications of same then you are well on the way to being able to trust your figures. Then it is incumbent on the accountant or management person to frequently check the profit position of the business by analysing:
1. Sales made for the period
a. Invoices (ensure all invoices have been taken up)
b. Check receipts for sundry allocations
2. Costs for the period by the appropriate product group
a. Payments
b. Creditor (supplier) invoices (also ensure all have been processed)
3. Check the product group profit for variations from your standard returns
4. Run live profit & loss report to check that total balances ‘look correct’
Take the time to set up your system and then run the analysis reports weekly and fully for each month.
I guarantee that you will improve your profit performance by breaking your sales into product groups and the more the merrier. In over 30 years of accounting, management consulting and software development I can vouch for the benefits in providing detail.
Many managers only like detail when it suits them whereas the good managers want nee demand the maximum amount of information to enable sound decision making and therefore a solid contribution to the company.
Business owners, chief executives and accountants should never accept anything else.
Start your product group restructure today…
Accounting - Sales and Profit Analysis - To learn more about this author, visit Walter Tegelaar's Website.
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