Analysis of Revenues and Expenses
Analysis of Revenues and Expenses
Analysis of Revenues and Expenses
Analysis of Revenues and Expenses
Since profit is revenues less expenses, to determine what your profit is you must first
identify all revenues and expenses for the period under study.
1. Have you chosen an appropriate period for profit determination?
For accounting purposes firms generally use a twelve month period, such as January 1 to
December 31 or July 1 to June 30. The accounting year you select doesn't have to be a
calendar year (January to December); a seasonal business, for example, might close its
year after the end of the season. The selection depends upon the nature of your business,
your personal preference, or possible tax considerations.
2. Have you determined your total revenues for the accounting period?
In order to answer this question, consider the following questions:
- What is the amount of gross revenue from sales of your goods or service? (Gross Sales)
- What is the amount of goods returned by your customers and credited? (Returns and
Rejects)
- What is the amount of discounts given to your customers and employees? (Discounts)
- What is the amount of net sales from goods and services? (Net Sales = Gross Sales
- Returns and Rejects + Discounts))
- What is the amount of income from other sources, such as interest on bank deposits,
dividends from securities, rent on property leased to others? (Non-operating Income)
- What is the amount of total revenue? (Total Revenue = Net Sales + Non-operating
Income)
3. Do you know what your total expenses are?
Expenses are the cost of goods sold and services used in the process of selling goods
or services. Some common expenses for all businesses are:
- Cost of goods sold (Cost of Goods Sold = Beginning Inventory + Purchases - Ending
Inventory)
- Wages and salaries (Don't forget to include your own- at the actual rate - you'd have to
pay someone else to do your job.)
- Rent
- Utilities (electricity, gas telephone, water, etc.)
- Delivery expenses
- Insurance
- Advertising and promotional costs
- Maintenance and upkeep
- Depreciation (Here you need to make sure your depreciation policies are realistic and
that all depreciable items are included)
- Taxes and licenses
- Interest
- Bad debts
- Professional assistance (accountant, attorney, etc.)
There are of course, many other types of expenses, but the point is that every expense
must be recorded and deducted from your revenues before you know what your profit is.
Understanding your expenses is the first step toward controlling them and increasing
your profit..
You find this ratio by dividing accounts receivable by daily credit sales. (Daily
credit sales = annual credit sales divided by 360.) This ratio tells you the length of
time it takes the firm to get its cash after making a sale on credit. The shorter this
period the quicker the cash flow is. A longer than normal period may mean overdue and
un-collectible bills. If you extend credit for a specific period (say, 30 days), this
ratio should be very close to the same number of day. If it's much longer than the
established period, you may need to alter your credit policies. It's wise to develop an
aging schedule to gauge the trend of collections (without adequate financing charges) hurt
your profit, since you could be doing something much more useful with your money, such as
taking advantage of discounts on your own payables.
8. Do you know your ratio of net sales to total assets?
This ratio (net sales divided by total assets) measures the efficiency with which you
are using your assets. A higher than normal ratio indicates that the firm is able to
generate sales from its assets faster (and better) than the average concern.
9. Do you know your operating profit to net sales ratio?
This ratio (the result of dividing operating profit by net sales and multiplying by
100) is most often used to determine the profit position relative to sales. A higher than
normal ratio indicates that your sales are good, that your expenses are low, or both.
Interest income and interest expense should not be included in calculating this ratio.
10. Do you know your net profit to total assets ratio?
This ratio (found by multiplying by 100 the result of dividing net profit by total
assets) is often called return on investment or ROI. It focuses on the profitability of
the overall operation of the firm. Thus, it allows management to measure the effects of
its policies on the firm's profitability. The ROI is the single most important measure of
a firm's financial position. You might say it's the bottom line for the bottom line.
11. Do you know your net profit to net worth ratio?
This ratio is found by dividing net profit by net worth and multiplying the result by
100. It provides information on the productivity of the resources the owners have
committed to the firm's operations.
All ratios measuring profitability can be computed either before or after taxes,
depending on the purpose of the computations. Ratios have limitations. Since the
information used to derive ratios is itself based on accounting rules and personal
judgments, as well as facts, the ratios cannot be considered absolute indicators of a
firm's financial position. Ratios are only one means of assessing the performance of the
firm and must be considered in perspective with many other measures. They should be used
as a point of departure for further analysis and not as an end in themselves.
The profit analysis of each major item help you find out the strong and weak areas of
your operations. They can help you to make profit-increasing decisions to drop a product
line or service or to place particular emphasis behind one or another.
Records
Good records are essential. Without them a firm doesn't know where it's been, where it
is, or where it's heading. Keeping records that are accurate, up-to-date, and easy to use
is one of the most important functions of the owner-manager, his or her staff, and his or
her outside counselors (lawyer, accountant, banker).
Basic Records
18. Do you have a general journal and/or special journals, such as one for cash
receipts and disbursements?
A general journal is the basic record of the firm. Every monetary event in the life of
the firm is entered in the general journal or in one of the special journals.
19. Do you prepare a sales report or analysis?
(a) Do you have sales goals by product, department, and accounting period (month,
quarter, year)?
(b) Are your goals reasonable?
(c) Are you meeting your goals?
If you aren't meeting your goals, try to list the likely reasons on a sheet of paper.
Such a study might include areas such as general business climate, competition, pricing,
advertising, sales promotion, credit policies, and the like. Once you've identified the
apparent causes you can take steps to increase sales (and profits).
Buying and Inventory System
20. Do you have a buying and inventory system?
The buying and inventory systems are two critical areas of a firm's operation that can
affect profitability.
21. Do you keep records on the quality, service, price, and promptness of delivery
of your sources of supply?
22. Have you analyzed the advantages and disadvantages of:
(a) Buying from several suppliers,
(b) Buying from a minimum number of suppliers?
23. Have you analyzed the advantages and disadvantages of buying through cooperatives
or other systems?
24. Do you know:
(a) How long it usually takes to receive each order?
(b) How much inventory cushion (usually called safety stock) to have so you can
maintain normal sales while you wait for the order to arrive?
25. Have you ever suffered because you were out of stock?
26. Do you know the optimum order quantity for each item you need?
27. Do you (or can you) take advantage of quantity discounts for large size single
purchases?
28. Do you know your costs of ordering inventory and carrying inventory?
The more frequently you buy (smaller quantities per order), the higher your average
ordering costs (clerical costs, postage, telephone costs etc.) will be, and the lower the
average carrying costs (storage, loss through pilferage, obsolescence, etc.) will be. On
the other hand, the larger the quantity per order, the lower the average ordering cost and
the higher the carrying costs. A balance should be struck so that the minimum cost overall
for ordering and carrying inventory can be achieved.
29. Do you keep records of inventory for each item?
These records should be kept current by making entries whenever items are added to or
removed from inventory. Simple records on 3 x 5 or 5 x 7 cards can be used with each item
being listed on a separate card. Proper records will show for each item: quantity in
stock, quantity on order, date of order, slow or fast seller, and valuations (which are
important for taxes and your own analyses.)
Other Financial Records
30. Do you have an accounts payable ledger?
This ledger will show what, whom, and why you owe. Such records should help you make
your payments on schedule. Any expense not paid on time could adversely affect your
credit, but even more importantly such records should help you take advantage of discounts
which can help boost your profits.
31. Do you have an accounts receivable ledger?
This ledger will show who owes money to your firm. It shows how much is owed, how long
it has been outstanding and why the money is owed. Overdue accounts could indicate that
your credit granting policy needs to be reviewed and that you may not be getting the cash
into the firm quickly enough to pay your own bills at the optimum time.
32. Do you have a cash receipts journal?
This journal records the cash received by source, day, and amount.
33. Do you have a cash payments journal?
This journal will be similar to the cash receipts journal but will show cash paid out
instead of cash received. The two cash journals can be combined, if convenient.
34. Do you prepare an income (profit and loss or P&L) statement and a balance
sheet?
These are statements about the condition of your firm at a specific time and show the
income, expenses, assets, and liabilities of the firm. They are absolutely essential.
35. Do you prepare a budget?
You could think of a budget as a "record in advance," projecting
"future" inflows and outflows for your business. A budget is usually prepared
for a single year, generally to correspond with the accounting year. It is then, however
broken down into quarterly and monthly projections.
There are different kinds of budget: cash, production, sales, etc. A cash budget, for
example, will show the estimate of sales and expenses for a particular period of time. The
cash budget forces the firm to think ahead by estimating its income and expenses. Once
reasonable projections are made for every important product line or department, the
owner-manager has set targets for employees to meet for sales and expenses. You must plan
to assure a profit. And you must prepare a budget to plan.