Accounting and Finance for Your Small Business Second Edition_13

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Accounting and Finance for Your Small Business Second Edition_13 Evaluating the Operations of the Business SECTION III Profit Center Reporting The last section was concerned primarily with reporting on opera- tional issues, such as machine utilization and scrap rates. However, these are of no import if a company cannot consistently create a profit or spin off enough cash flow to keep those operations run- ning. In this section, we review the concept of profit centers, and how one should report their results. Every company creates and issues an income statement that reveals the financial performance of the entire company. For smaller organizations that deal with just a single line of business, such as a plumbing service company, this is sufficient. However, if there are several lines of business, such as a plumbing service group, a plumbing hardware store, and an air conditioning repair staff, then the revenues and costs of each one should be recorded separately, so that management can see if some areas are less profitable than others. An example of this report is shown in Figure 9.8, where we list a separate income statement for each profit center, which sum- marizes into the summary-level income statement for the entire company, as shown at the far right side of the report. Also in the report is a separate column for corporate overhead. These are costs that cannot be specifically allocated to a profit center. The basic rule for making the allocation determination is whether an overhead cost will disappear if a profit center is eliminated; if not, then do not allocate the overhead cost to the profit center. Also, there is an interest expense charged to each profit center, based on the amount of fixed assets and working capital that each one uses. Finally, after the profit figures at the bottom of the report, we add back the depreciation expense for each profit center (since this is a noncash expense), which yields the actual cash inflow or outflow to or from each profit center. The report reveals that the plumbing hardware store is making very little money, partially because of the interest expense charged to it that covers the cost of funds for the store facility and inventory (as pointed out by the arrows in the figure). Both service groups, having no significant assets, have a much lower interest expense and so earn a larger profit. Based on this analysis, it is evident that the hardware store is a drag on the over- all corporate earnings percentage. 282 Reporting CHAPTER 9 FIGURE 9.8 Profit Center Income Statement (000s) Air Summary Plumbing Plumbing Conditioning Corporate Income Description Service Hardware Repair Overhead Statement Revenue $1,400 $1,750 $972 $0 $4,122 Direct Expenses: Material 625 1,115 410 0 2,150 Direct Labor 450 250 350 0 1,050 Total Direct Cost 1,075 1,365 760 0 3,200 Total Direct Margin 325 385 212 0 922 Direct Margin Percentage 23% 22% 22% 0% 22% Overhead Allocation 14 57 14 375 460 −375 Gross Margin 311 328 198 462 Gross Margin Percentage 22% 19% 20% — 11% General & Administrative 25 85 25 175 310 Interest Expense 42 193 29 0 264 −550 −112 Net Profit (Loss) 244 50 144 −3% Net Profit Percentage 17% 3% 15% — + Depreciation Expense 21 81 21 37 159 −513 Cash Inflow (Outflow) 264 131 165 47 Capital Usage: Working Capital 325 1,578 175 0 2,078 Fixed Assets ...