The numbers don’t lie…but do you know what they’re saying?

When someone starts a business, there is no doubt it is something they are passionate about, and that passion, combined with tireless work ethic and devotion is what makes their business a success.  At these early stages of a business’ life, success is fueled by that gut-feeling.  What will work and what won’t. 

Once you’ve reached a moderate level of success with your business, and things get bigger and bigger, you might find your ‘gut-feel’ abilities reaching their limits.  Demand for your product far surpasses your supply, and you know that if you want to keep growing your business, you need to make some big (read: expensive) decisions. 

My favourite saying is, “the numbers don’t lie.”  I know I didn’t make that one up, but I used it very frequently during my professional career in corporate accounting.  The numbers sure don’t lie, but do you know what they’re saying? 

There are so many cloud-based accounting software offerings out there, making what was once the cumbersome task of accounting into something you can easily manage on an app on your phone.  Up in the cloud, your bank will communicate with your accounting software and do all the heavy lifting for you.  Most tasks historically done by manual input have been eliminated, or severely reduced.    

A very popular cloud financial software is QuickBooks Online (QBO).  QBO, right out of the box, can show you your up-to-date profit & loss for whichever time period you select:

For a consulting business, this type of reference tool is all that you may need to feel on top of your finances, you don’t even need to give them a second thought.  However, if your business has many different product offerings, the true insight you have into your business will be limited by how effectively you structure your General Ledger (GL), or Chart of Accounts (COA).

To illustrate this, I’m going to use a fictional company called Food4U Catering (F4U).  F4U was started by an aspiring chef in 2018 and has grown significantly over the past few years.  2020 was its best year yet.  When F4U became a legitimate business, the founder implemented QBO to handle the day-to-day finances for F4U.  Invoices are coded to Sales, and direct costs to provide the catering, such as purchased food and staff to prepare the food, were coded to Cost of Goods sold.  Their simplified 2020 earnings statements looks like this:

 This shows that they sold their $250,000 worth of catering packages to their customers in 2020, and spent $150,000 to do so.  The gross profit for 2020 would be $100,000, or 40% of sales – not bad!

The demand for F4U has skyrocketed due to COVID, as people are no longer able to dine in large groups in restaurants.  Many of F4U’s clients have held company gatherings outdoors.  With the current trends, this demand is going to stay steady but most likely will increase even further as restaurants unfortunately go out of business. 

The owner of F4U has some decisions to make.  Their kitchen was FULL all year producing as much catering as possible, so the sales numbers seen in 2020 cannot increase without expanding the kitchen size.  Is that what should be done?  With the setup of the current financials, it’s hard to tell.

Let’s imagine instead of putting all sales to “Sales” and all costs to “Cost of Goods Sold” that the owner had broken things out a bit more granularly, to align more closely with the various types of catering packages.  Sales would be broken out into three categories:  Hot Lunch, Baked Goods and Savoury Soups.

For this to work, the expense categories must also be broken out into these three categories, with costs properly allocated amongst them. 

I have rearranged the finances for F4U in this manner:

When the numbers are broken out this way, the owner of F4U is shocked to learn that they are barely making money on their baked goods!  This is frustrating because the baked goods take the most space in the kitchen to prepare, and take the most staff time to complete. 

Looking at the numbers this way, the owner realizes something – they don’t need a bigger kitchen, they need to stop offering baked goods!  Eliminating that product offering will increase the amount of space in the kitchen to prepare their more profitable offerings: the hot lunches and savoury soups. 

Assuming they had not offered baked goods in 2020, here is a mock-up of their numbers.  Since demand was insatiable, we will assume they were able to make up the sales numbers in hot lunches and soups:

Keeping the profit margin consistent, the costs to make the additional lunches and soups were added in.  This shows that the profit for 2020, had F4U only focused on their most profitable offerings, would have been $141,917 instead of $100,000. 

Having this insight into which of their offerings are profitable vs. not, is essential for the owners to make decisions, such as the decision to eliminate baked goods from their menu. 

When you set up your accounts, you need to do so in a manner that tells the story of your business at a very granular level, however, not so granular that it is too cumbersome to track.  There is a perfect sweet spot for your company.