Analyzing Results Using The Income Statement

Chapter 9Analyzing Results Using The Income StatementMain IdeasIntroduction to Financial AnalysisUniform System of AccountsIncome Statement (USAR format)Analysis of Sales/VolumeAnalysis of Food ExpenseMain Ideas (cont.)Analysis of Beverage ExpenseAnalysis of Labor ExpenseAnalysis of Other ExpensesAnalysis of ProfitsTechnology ToolsIntroduction to Financial Analysis Part of management’s job is to sift through information and select for analysis those numbers that can shed light on exactly what is happening in their operations. Among other things, they will want to determine:How much money did we take in?How much money did we spend?How much profit did we make?Introduction to Financial AnalysisDocumenting and analyzing sales, expenses, and profits is sometimes called cost accounting.However, that same activity is more appropriately described as managerial accounting, to reflect the importance managers should place on the process.Introduction to Financial AnalysisBookkeeping is the process of recording and summarizing financial data.Managerial accounting is the analysis of recorded and summarized data. Effective managerial accounting decisions rely upon accurate bookkeeping.Introduction to Financial AnalysisFinancial reports related to the operation of a foodservice facility can be of interest to:ManagementStockholdersOwnersCreditorsGovernmental agenciesThe general publicIntroduction to Financial AnalysisManagers do not have to be a Certified Management Accountant (CMA) or a Certified Public Accountant (CPA) to analyze data related to foodservice revenue and expense.In 2002, the United States Congress passed the Sarbanes-Oxley Act (SOX). This law imposes criminal penalties for those found to have committed accounting fraud. Uniform System of AccountsThe National Restaurant Association has developed the Uniform System of Accounts for Restaurants (USAR). The USAR seeks to provide a consistent and clear manner in which managers can record sales, expenses, and overall financial condition.The uniform systems of accounts are guidelines, not a mandated methodology.Managers should secure copies of appropriate uniform system of accounts for their operations and be familiar with its formats and reporting principles.Income Statement (USAR format)The Income StatementThe income statement, (P&L) is a summary report that describes the sales achieved, the money spent on expenses and the resulting profit generated by a business in a defined accounting period.Each operation’s P&L statement may look slightly different.Managers may prepare annual, quarterly, monthly, or even weekly income statements. Income Statement (USAR format)The Income StatementA precise definition of exactly what is meant by the term “profit” must be established for each P&L statement prepared if it is to be helpful and communicate information accurately.One purpose of the P&L statement is to identify net income, which is the profit generated after all expenses of the business have been paid. The Income Statement (USAR)The Income Statement (USAR) (continued)The Income Statement (USAR)Income statements list revenue first, then expense, and finally the difference between the revenue and expense figures.If the difference is positive, it represents a profit.If expenses exceed revenue, a loss, represented by a negative number or a number in brackets, is shown.Operating at a loss is often referred to as operating “in the red” or “shedding red ink.”The Income Statement (USAR)A foodservice operation’s income statement (USAR) can best be understood by dividing it into four sections:(1) Sales(2) Prime cost(3) Other controllable expenses(4) Non-controllable expenses. These sections are arranged on the income statement from most controllable to least controllable by the foodservice manager.The Income Statement (USAR)The Sales category includes the revenue generated by all of the food and beverage purchases made by guests.The Prime cost section of a P&L details the amount that was spent for food and beverages as well as the total amount spent for labor. Prime cost is defined as an operation’s total cost of sales added to its total labor cost.The Income Statement (USAR)Revenue and expense categories on the income statement are most often presented in two ways:1. Whole dollar amounts2. Percentages of total sales. The Income Statement (USAR)All expense ratios are calculated as a percentage of total sales except the following:Cost of Sales: Food is divided by food salesCost of Sales: Beverage is divided by beverage salesThe Income Statement (USAR)The income statement is an aggregate statement; or summary of income and expense.Detailed income and expense information can be found in supporting schedules. The Income Statement (USAR)The P&L statement is only one of several documents owners use to help evaluate the success of a business.The P&L statement alone, however, yields important information that is critical to the development of future management plans and budgets.The Income Statement (USAR)By reviewing their P&Ls managers can analyze six critical operational areas:1. Sales/volume2. Food expense3. Beverage expense4. Labor expense5. Other controllable and non-controllable expense6. Profits Analysis of Sales/VolumeSales increases or decreases are computed using the following steps:Step 1 Determine sales for this accounting period.Step 2 Calculate this period’s sales minus last period’s sales.Step 3Divide the difference in step 2 by last period’s sales to determine the sales percentage variance.Analysis of Sales/VolumeAnalysis of Sales/VolumeFoodservice operations can experience total sales increase in several ways. These are:Serving the same number of guests at a higher check average.Serving more guests at the same check average.Serving more guests at a higher check average.Serving fewer guests at a much higher check average.Analysis of Sales/VolumeThe procedure to adjust sales variance to include menu price increases is:Step 1.Increase prior period sales (last year) by amount of the price increase.Step 2.Subtract the result in Step 1 from this period’s salesStep 3. Divide the difference in Step 2 by the value of Step 1. Analysis of Sales/VolumeAnalysis of Food ExpenseA food cost percentage can be computed for each food subcategory. For instance, the cost percentage for the category Meats and Seafood would be computed as follows:Meats and Seafood CostTotal Food SalesMeats and Seafood Cost %Analysis of Food ExpenseAnalysis of Food ExpenseAnalysis of Food ExpenseIncome statements prepared in other countries can vary in format from the income statements prepared according to USAR recommendations. One example of this relates to the concept of profits.Income statements in some countries are prepared in a way that indicates an operation's Gross Profit. Total Sales (-) Total Cost of Sales = Gross ProfitAnalysis of Food ExpenseInventory turnover refers to the number of times the total value of inventory has been purchased and replaced in an accounting period.The formula used to compute inventory turnover is:Cost of Food ConsumedAverage Inventory ValueFood Inventory TurnoverAnalysis of Food ExpenseThe average inventory value is computed as follows:Managers must ensure a high inventory turnover is caused by increased sales and not by increased food waste, food spoilage, or employee theft.Beginning Inventory Value + Ending Inventory Value2Average Inventory Value Analysis of Beverage ExpenseManagers should analyze beverage expenses in the same manner as they analyze food expenses. To analyze the beverage expense category managers compute their beverage cost percentages, compare them to planned or targeted beverage expense, and then compute a beverage inventory turnover rate.Analysis of Beverage ExpenseBeverage inventory turnover is computed using the following formula:Cost of Beverages ConsumedAverage Beverage Inventory ValueBeverage Inventory TurnoverAnalysis of Beverage ExpenseIf an operation carries a large number of rare and expensive wines, it will find that its beverage inventory turnover rate is relatively low.Conversely, those beverage operations that sell their products primarily by the glass are likely to experience inventory turnover rates that are quite high.Analysis of Beverage ExpenseAll food and beverage expense categories should be adjusted both in terms of costs and selling price if effective comparisons are to be made over time.As product costs increase or decrease, and as menu prices change, so too will food and beverage expense percentages change.Analysis of Labor ExpenseWhen total dollar sales volume increases, fixed labor cost percentages will decline.Variable labor costs increase along with sales volume increases, but the percentage of revenue they consume should stay relatively constant.Analysis of Labor ExpenseDeclining costs of labor may be the result of significant reductions in the number of guests served.Effective foodservice managers seek to achieve reductions in operational expense because of improved operational efficiencies, not because of reduced sales or unintended reductions in guest service levels.Analysis of Labor ExpenseSalaries and wages expense percentage is computed as follows:Salaries and Wages ExpenseTotal SalesSalaries and Wages Expense %Analysis of Labor ExpenseAnalysis of Labor ExpenseCOLA (Cost of living adjustment) and/or raises and changes in menu prices will affect labor costs.Managers adjust both sales and cost of labor using the same steps as those employed for adjusting food or beverage cost percentage; as follows:Step 1. Determine sales adjustmentStep 2. Determine total labor cost adjustmentStep 3. Compute adjusted labor cost percentage.Analysis of Labor ExpenseThis year’s projected labor cost is computed as follows:Increases in payroll taxes, benefit programs, and employee turnover can all directly affect labor cost percentage.This Year’s SalesLast Year's Adjusted Labor Cost PercentageThis Year’s Projected Labor CostAnalysis of Other ExpenseAn analysis of other expenses should be performed each time the P&L is prepared. For operations that are a part of corporate chain, unit managers can receive comparison data from district and regional managers who can chart performance against those of other operators in the city, region, state, and nation.Analysis of Other ExpenseAnalysis of ProfitsProfit margin represents the amount of profit generated on each dollar of sales. It is that portion of a dollar’s sale returned to the operation in the form of profits.Profit margin is also known as Return on Sales, or ROS. ROS is often the most telling indicator of a manager’s overall effectiveness at generating revenues and controlling costs in line with forecasted results. Analysis of ProfitsProfit margin percentage is calculated using this formula:Net IncomeTotal SalesProfit MarginAnalysis of ProfitsWhile it is not possible to state what a “good” ROS figure should be for all restaurants, industry averages, depending on the specific segment, range from 1% to over 20%.Some operators prefer to use operating income as the numerator for the profit margin formula instead of net income. Thus is because interest and income taxes are considered nonoperating expenses and thus, not truly reflective of a manager's ability to generate a profit.Analysis of ProfitsEffective managers are concerned about both the dollar amount of profit they generate and their ROS percentages.ROS can be a positive number; and when it is, a profit has been generated.ROS can be a negative number; and when it is, a loss has been incurred. Analysis of ProfitsAn operation’s profit variance % for an accounting period is measured by the following formula: Net Income This Period – Net Income Last PeriodNet Income Last PeriodProfit Variance %Analysis of ProfitsPerceptive foodservice operators recognize that profits, planet, and people all benefit from an operation’s green commitment.“Planet friendly” management yields many positive financial outcomes for businesses, as well as for the health of the local communities they count on to support them.Buying local creates relationships with those who produce food and keeps money flowing through a local economy.Technology ToolsThis chapter introduced the concept of management analysis as it relates to sales, expenses, and profits. In this area software is quite advanced; thus varied tools are available to help managers:Analyze operating trends (sales and costs) over management-established time periods.Analyze food and beverage costs.Analyze labor costs.Analyze other expenses.Technology ToolsAnalyze profits.Compare operating results of multiple profit centers within one location or across several locations.Interface with an operation’s point of sales (POS) system or even incorporate its information completely.“Red flag” areas of potential management concern.Technology ToolsEvaluate the financial productivity of individual servers, day parts, or other specific time periods established by management.Compare actual to budgeted operating results and compute variance percentages as well as suggest revisions to future budget periods based on current operating results.