Even though a business may be profitable, it is essential to know which areas of a business are profitable, and the areas in which the company may be running at a deficit. Understanding the profitability of the individual departments in a business will allow a business owner to optimize their business so that it is performing at the highest rate possible. Cogent Analytics helped this client improve their accounting system, as well as their organizational structure through organizational engineering so that they could see where they are making or losing profit.
The client is a supplier to the propane industry. They provide construction services for building bulk distribution plants, maintenance services to the same plants; the company also assists with maintaining the delivery trucks as well a building new delivery trucks for the propane dealers.
STATUS / SITUATION / CHALLENGES
The company is profitable, but the owners did not know exactly where there were making money or where they may be losing money on the various services and products that they sell.
The first step in updating the company into departments was to change their accounting process so the revenue and expenses could be segregated into profit centers or departments.
Their current accounting system made this very difficult to split the expenses by department. However, it was quite easy to segregate the income and Cost of Goods Sold (COGS) to the profit centers. Therefore, the decision was made to use an Excel spreadsheet in conjunction with the Profit & Loss statement to produce a departmentalized Profit and Loss Statement every month.
The second step was centered on the need to break down and decipher the departments within the organization. We decided upon three departments; Construction & Plant Maintenance, Vehicle builds and maintenance, and on the road certifications. We would have like five, splitting the first two departments into two separate departments, but currently, they were too intertwined with each other, but it is possibly an option in the future.
The next step was to add additional accounts in the accounting system, so the sales and Cost of Goods Sold could be tracked separately. We also set up a training guide for the data entry clerk of how to code the invoices and bills to the proper account. This is a new process since, in the past, all invoices went to one account ‘Sales.’ There were multiple accounts for the Cost of Goods Sold, but we added additional accounts for better segregation of costs between the new departments, such as, the direct payroll account, this account was a total for the shop and field employees, the office personnel were already listed in the expense section of the Profit & Loss statement.
The company uses an internet app for job costing. The jobs were then coded to the departments, and the employees use the app for all timekeeping. A standard journal entry was developed, so when the payroll was processed, the costs could be allocated to the proper department when payroll is processed.
The previous step was one of the most straightforward changes to make in the process. However, the allocation of the overhead expenses was the challenge in the development of a departmental P & L statement. Their accounting system made it difficult to split a bill to different departments, and that is where the Excel spreadsheet comes into use.
The segregation of overhead expenses is where a spreadsheet was required to allocate the expense to different departments. With the owners, we reviewed the expenses on a line by line basis to determine the best method of allocating expenses.
The expenses such as office wages, where there was no easy way to determine how much time they spend working with a specific department, we allocated that expense to the percentage of revenue for that department. The reasoning behind this decision, more revenue most likely means more work for that department.
Some expenses, such as advertising, could be department-specific, or it could be a general expense.
With these expenses, we added some additional accounts. We now have Advertising General, Advertising – Construction, Advertising – Shop, Advertising – Road. So, the department-specific expenses were allocated 100% to that department. The general costs were allocated as above, percent of revenue.
With this allocation set up and put into a spreadsheet, we able to determine the overhead distribution for each of the three individual departments. This allowed the owners to adjust the pricing formula for each of the three departments. With the new pricing formula, they could become more competitive in the unique business segment. All three departments were profitable, and the Truck/Shop work was more profitable than they thought.
The spreadsheet was also built so it would become a monthly variance report, and they can review the profitability on a monthly basis, and adjust the business as needed, why go through all this extra work in keeping financial records? Better control of the company!
Since instituting a better accounting system along with this company departmentalization, the owners now know the profitability of each of individual departments and can now plan accordingly. The three different market segments the company serves have different pricing structures.
The construction department, for example, has low facility expenses, but high vehicle costs due to large fleet since most of the work is more than 20 miles from the shop. The shop uses most of the facility, and any addition/improvement of the facility would need to be justified by that department because the other two departments would not require additional space. While the least profitable as a percentage of revenue, the owners have peace of mind that the on the road service is profitable.
At Cogent Analytics, we never stop looking for ways to improve your business, and neither should you. So, check out some of our other posts in the Knowledge Center for helpful business information:
Cogent Analytics, LLC is a business management consulting firm with a primary focus to help small to medium size, privately held businesses achieve success and long term profitability. Cogent provides robust solutions with integrity and transparency to privately-held companies throughout the United States.