Monday, July 20, 2009

Understanding your profit and Loss Statement

Demystifying the Profit and Loss Statement for yourselves and your team comes down to a practice of defining terms followed by constant repetition.

People, Sales and Profit
Think of your business as a triangle with three sides of equal importance. If you maintain focus on each side of the triangle, then you have a good chance at running a successful business. However, if one side of the triangle is out of balance, your chances of success are much lower.

The People side of the triangle addresses recruiting, training, retention and team building. Many of us are natural with others and enjoy the People side of the business. Since we tend to gravitate towards comfort zones, skills related to people usually are not intimidating or foreign for most restaurant operators.

The Sales side of the triangle is often a natural part of a restaurant operator’s style as well. Managers and team members easily buy into learning and teaching strategies of up selling, making recommendations and competing in contests. It is not difficult for most operators to encourage movement of your most profitable products.

Unfortunately, managing the Profit side of the triangle can be very challenging. Teaching your team members how to operate the restaurant to the guest’s satisfaction is only part of the picture. Your team needs to understand the basic components of the Profit and Loss statement in order to successfully manage your profitability.

Breaking categories down to the lowest common denominator, the statement is simply comprised of Revenues minus Expenses with an outcome of a Profit or a Loss. Once your team members understand the main components, it becomes fairly straight forward to expand the definition and makeup of the P&L Statement.

The P&L Statement is simply a snapshot, a moment in time, much like a photo. It represents a period of time and reflects the sales, cost of goods sold, expenses and profit or loss. It is simply a report card, nothing more. The P&L Statement lets you know how you performed compared to budget, how you are doing versus last year and many other comparisons that let you know if you are winning and, if not, where the opportunities for improvement lie. Use the P&L as an opportunity to recognize achievement and praise the team for a job well done, and for corrective action where needed. When you measure performance you are able to manage the result.

Use a simple format similar to the one below to explain the P&L Statements make-up and flow.

Revenue Less Cost of Goods Sold = Gross Profit Less Labor Less Operating Costs = Operating Income

Teaching the ins and outs of the P&L Statement does not have to be torture. If the Statement is generated regularly, simple repetition will ingrain the basics of the numbers. Ensure your entire team has access to repetitive discussions and involvement with the Profit and Loss statement.

Break the statement down to the lowest common denominators to start. Teach your team that the P&L Statement is simply Revenue minus Expenses.

Clearly explain each term so that everyone has the same understanding and uses the same definition.

Key definitions that the team needs to understand include:

Revenue - Compensation for your products or services. This line represents anything captured within the cash register or POS system.

Cost of Goods Sold - This term represents the variable expense related to the sale of your products. Most of the cost of goods sold includes food and beverage items.

Operating Expenses - These are the daily expenses of running the business: supplies, G&A, rent, etc.

EBITDA - Earnings before interest, taxes, depreciation and amortization. You need to ensure that your team members understand the importance of this line item. It basically is a report card line on the things for which the store managers and employees can have a direct impact. You may want to consider using the EBITDA line as an incentive line or bonus line for performance.

Income Taxes - Federal, state and local

Net Earnings - The end result and hopefully the Profit earned by the business.

With the basic word definitions under control, each team member needs to have an understanding of how the P&L Statement becomes populated with numbers. The difference between Gross Sales and Net Sales is an important first step.

Gross Sales includes everything captured within the cash register or POS system.

Net Sales includes everything for which compensation was collected.

Usually the difference is made up of items that were “comped” for some reason.

Cost of Goods Sold is simply Beginning Inventory + Purchases – Ending Inventory. Understanding the formula that leads to the number enables team members to break down and investigate the process of expense flow through the system.

Controllable Expenses are an important area to work on. Show what it means to drop a plate, to waste napkins, to overuse chemicals. Team members need to understand the profit repercussions of equipment neglect, overuse of supplies and the cost associated with stacking glassware. When you show the actual cost per piece and how the expense lands on the P&L Statement it’s easy to see how these costs impact profits.

Your team also needs to have a good understanding of the difference between Fixed and Variable costs. Focusing on the difference in Fixed and Variable costs can lead to more awareness about the importance of sales growth.

Fixed expenses such as rent, service contracts and management salaries remain constant and increasing sales helps offset the impact these expenses have on the P&L Statement.

Variable costs, on the other hand, are driven by the ebbs and flows of the business. Variable costs such as hourly labor, food costs and beverage costs dictate that we focus on sales fluctuations so that purchasing and labor can be adjusted accordingly. Planning to address variable cost requires your team to be in
a proactive mode versus a reactive mode.

Understanding the importance of the P&L Statement is a vital part of running the business successfully. If you expect to maximize the potential of your business and the performance of your team members, it is crucial that you spend consistent quality time focusing on the components of the P&L Statement as well as teaching the process from where the numbers come, how they are presented on the P&L Statement and, most importantly, how you can impact the outcome of the P&L Statement. Sound fiscal management is an everyday practice operators must constantly develop throughout the team.

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