While most every entrepreneur knows that watching and controlling expenses must be done, many don’t know where to start. Here’s a primer on how to analyze your business expenses.
Analyze the Income Statement
For every line item in the operating expenses, calculate the dollar amounts and percentages of revenue. (Your accounting reporting system should be able to spit out “canned” reports like this very easily.) How do they compare to last month? To the last three months? To the average of the last three months (rolling average)? To the average year-to-date? To the same month last year? Don’t spend the same time on all items. Start with the biggest dollar amounts and the biggest percentage of revenue amounts and work down the list. Most importantly, look at the “why” behind the numbers. I had a client whose parking ticket fines for his big-city delivery trucks jumped significantly compared to the last quarter and last year. Turns out the city had tightened its enforcement guidelines. We shifted our delivery schedules and hired a ticket-fighting service that more than paid for itself in reduced fines.
Compare “Actuals” to Budgets
One of the most important financial management disciplines (right after getting those timely and accurate financial statements!) is the creation and use of a budget. The exercise of examining all your expenses and estimating what they will be next year is critical. It gets you thinking of the drivers of each expense. Your estimates WILL be off, but if you understand the drivers, you will be able to understand why, whether they are significant or not, and how to fix them. Do all the same analyses that I listed for actuals for the actual vs. budget amount.
Calculate Rolling Averages
I mentioned rolling averages above, but they bear highlighting. A rolling average is calculating the average of an expense over the last x periods doing it every period to look at the change. Rolling averages of key performance indicators can smooth out unimportant small drops or highlight cumulative small changes that are significant.
Now that you have all these numbers, you may be feeling numb or buried. Maybe you don’t like or feel comfortable with numbers at all! Have them put into charts. Charts communicate visually and with much more impact than reams of numbers. I coached the CFO of a major home health agency that gave a 1” thick stack of dense number reports to his CEO and Board every month. They felt disconnected from the business. We looked for the most significant numbers, put them into charts and gave the Board a 10-page report every month. They were delighted and were able to start asking better questions and ultimately make better decisions.
Now that you’re using charts, boil them down to the absolutely most significant numbers and trends and compile them into a dashboard. There are dashboard programs that can extract and present the data automatically so the owner and managers can instantly spot trends and problems. How valuable would this be to you? Could you sleep better at night knowing your dashboard won’t let you down?
Make Industry Comparisons
Reliable and relevant industry numbers can be hard for a single business owner to come by. We use a commercial service called ProfitCents by Sageworks to get good industry comparisons. Lacking that, ask other owners of businesses of similar size and industry that you don’t compete with, like those in other geographic areas. Does your industry trade association have or publish expense ratios? I worked with an owner who initially thought his sales expense were very low. ProfitCents said they were double his industry average! An effective revamping of the sales effort followed and we were able to save over $100,000 per year.
Rinse and Repeat!
As with many good management practices, the analysis of expense and how they are trending is not a one-shot deal. Build this disciple in to your processes and you will make more money and grow the value of your business.
Your accounting staff may be able to help with implementing these ideas, or contact me at email@example.com or call 732-977-9218!