During the last couple of weeks, I’ve had the opportunity to review a few new income statements. What I saw was pretty typical . . . too many lines. Both had over 150 line items. It is clear that the information that I reviewed is not being used to manage the business. There is just no clear organization to the income statement.
The issue is less the actual number of line items than the fact that they are not subtotaled into any logical order. I organized one of these income statements into 23 lines. The largest expense item was for employee costs which accounted for 77% of total expenses (more about that later). My “all other” line item (I almost always have one of these) accounted for only 7% of total costs.
Income statements like the ones I describe often fail to use account numbers. Lacking account numbers, the usual default is that the income statement is organized alphabetically. Just what are the chances that the most important line items in any business start with “A” and the least important ones start with “Z”? Obviously, the answer is “very little”.
Capturing 77% of your costs in one line item provides no detail on the single biggest expenditure of the business. Knowing that 77% of your cost is for payroll doesn’t tell you anything about how those dollars are deployed across departments or activities.
I also see too many line items that just aren’t material to the business. Some are so small that they have only had a few hundred dollars of expenditures in them on an annual basis. As long as you can get to the detail, these should be grouped into a few larger accounts which will likely provide some month to month consistency for forecasting purposes at the same time as well as being easier to review each month.
Hare are a few thoughts about organizing financial information in a way that is meaningful to the reader (usually the executive management team). Ultimately, the goal of these statements is to be a tool. With that in mind, I’d suggest:
o Organize around your most significant costs – use cost centers rather than more line items if you want to understand costs by department.
o Know that you will have some miscellaneous costs, but as long as you can get to the detail, you don’t need a line item for every $200 item.
o Use account numbers to avoid confusion between income and balance sheet items.
o Talk to your accountant about where non-operating costs should be captured. Too often these end up in the middle of the income statement. Typical examples are interest expense and interest income (I frequently see the latter in the revenue category).
o Learn how to properly record payroll expenses; these are usually booked incorrectly every pay period and the outside CPA makes a correcting entry at year end. Why not book them correctly each payroll period?
o Book an estimated depreciation amount every month. Sure, there will be a true-up at year end, but you should know approximately how much fixed asset depreciation you need to cover each month.
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