Chapter 19 - The Profit and Loss Statement

Definition and purpose | Abuse of purpose | Three basic rules to increase the usefulness of financial statements | Explanation of format | Analysis of format | Determination of departmental productivity | Gross profit analysis | Departmental performance standards | Bar standards | Payroll standards | Use of percentages | Management index of effectiveness

Definition and Purpose

The profit and loss statement is a financial summary of the money or claims for money received by a business unit and the cost in terms of money to produce the goods and services that a business unit sells during the accounting period. The basic purpose of the statement is to present management with an analysis of the business changes that have taken place from one balance sheet to another.

This financial record should not only provide management with a detailed summary of sales and costs, trends of business volume and expense, but also give each operator a comprehensive report of mana­gerial efficiency and responsibility, an accurate measure of the various revenue producing departments' productivity, a break even point and a closing point of operations, and a host of other aids to use for in­creased over all effectiveness.

Unfortunately the design and format of the typical profit and loss record makes it difficult if not impossible to use as a major manage­ment tool. Customarily, different type sales or costs are grouped to­gether in such a manner that the important information is distorted or completely hidden. The only use a financial statement of this type may have for a manager is to provide him with a record for income tax purposes.

Effective Format and Design

There are three basic rules that can be used by any operator to ma­terially increase the usefulness of the profit and loss statement. These are:

1. All operating expenses should be placed into two broad classifications: controlled and scheduled expenses.

2.  In order to compare the relative productivity of revenue pro­ducing departments, the revenue and cost of goods or services sold and other direct departmental costs should be distinctively grouped and kept separately classified by departments.

3. To provide exact measurements of changes in sales or costs, columns for comparative analysis should be added to the for­mat. Space should be provided so that each major cost figure can be compared both as dollar amounts and as percentage of sales.

Explanation of Format

The reason that the term "period" is used instead of current month, current quarter or year is that restaurant operators use various ac­counting cycles. A profit and loss statement may be made annually, bi-annually, quarterly, monthly. The principle disadvantage of an annual statement as opposed to the monthly is that the pertinent in­formation comes too late to be of any value. For this reason, also, a monthly statement is illustrated. (See following pages.)

This statement compares February's operation with January's. An accounting cycle of 4 weeks is much more valuable for the simple rea­son that a 4 week cycle would contain the same number of days and the same number of week ends and week-days. Thus, for comparative purposes one accounting period is comparable with the other and trends in sales or costs are determinable and predictable.

The sales percentages were obtained by dividing each departmental sales figure by the total sales figure. For example, the 74 percent food sales figure was obtained by dividing $30,000 food sales by 40,500 total sales.

The cost of sales and the departmental payroll percentages were obtained by taking the cost of sales and the direct payroll figures of each department and dividing each figure by the sales of the depart­ment involved. For example, the $12,000 food cost was divided by the 30,000 food sales to obtain the 40 per cent food cost. Similarly, the food departments direct payroll of 6,000 was divided by food sales, 30,000, to obtain the payroll cost percentage shown—20 per cent.

All other percentages were obtained by dividing each expense figure by total sales.

In the sales row the department shown as "other" represents any one of the various revenue producing departments (including food and liquor) that may be found in larger restaurants. Examples of other revenue producing departments may be cashier's sales (the sales of gum, candy, cigarettes, etc.), gift shops, take-out departments such as frozen food, bakery, boxed candies. The principle emphasized here is that the only way to judge any revenue producing department's profit­ability is to keep departmental sales separate from total sales and departmental costs separate from total costs.

COMPARATIVE OPERATING STATEMENT FOR CURRENT PERIOD, PAST PERIOD, AND YEAR TO DATE

	FEB		JAN		TO DATE
	Amount	%	Amount	%	Amount	%
SALES: Food	30,000	74.0	32,000	76.1	62,000	75.0
Bar	10,000	24.6	9,000	21.4	19,000	23.0
Other	500	1.2	1,000	2.3	1,500	1.7
TOTAL SALES	40,500	100	42,000	100	82,500	100
COST OF SALES: Net Food Cost	12,000	40.0	13,440	42.0	25,440	41
Net Bar Cost	3,000	30.0	2,520	28.0	5,520	29
Other Cost	250	50.0	500	50.0	750	50
TOTAL COST OF SALES	15,250	37.4	16,460	39.1	31,710	38.2
GROSS PROFIT	25,250	62.6	25,540	60.8	50,790	61.7
CONTROLLED EXPENSES:        Payroll – Food Department	6,000	20.0	6,760	18.0	12,760	19.0
Bar	1,000	10.0	810	9.0	1,810	9.5
Other	150	30.0	150	15.0	300	22.5
Administrative, Mgt.	2,025	5.0	2,016	4.8	4,041	4.9
Administrative, Clerical	810	2.0	881	2.1	1,691	2.05
Employee Meals	1,215	3.0	1,386	3.3	2,601	3.15
Payroll Tax	200		225		425
Utilities	400		445		845
Repairs & Maintenance	350		407		757
Advertising	500		600		1,100
Travel Expense	250		225		475
Paper Supplies	200		185		385
Menus & Stationery	100		150		250
Clean & Other Supplies	100		100		200
TOTAL CONTROLLED EXPENSES	13,300	32.8	14,340	34.1	27,640	33.5
SCHEDULED EXPENSES:             Rent	2,025	5.0	2,025	4.8	4,050	4.9
Insurance	500	1.23	500	1.1	1,000	1.2
Licenses	2,025	5.0	2,025	4.8	4,050	4.9
Interest & Bank Charges	1,015	2.5	1,015	2.4	2,030	2.45
Depreciation	2,025	5.0	2,025	4.8	4,050	4.9
TOTAL SCHEDULED EXPENSES	7,590	18.7	7,590	18.0	15,180	18.35
TOTAL ALL COSTS & EXPENSES	36,140	89.3	38,390	91.4	74,530	90.35
NET PROFIT BEFORE INCOME TAX	4,360	10.7	3,610	8.6	7,970	9.65

Statement Analysis

Notice that the departmental sales figures give management consid­erably more information than the gross sales figure alone can give. The gross sales figures point out that sales have dropped $1,500 in Feb­ruary compared to January's operation. Thus, gross sales data only reveals trends in total sales. The departmental sales figures, however, show a $2,000 loss in food sales, a $1,000 increase in bar sales and a 100% increase in other sales. This specific information pinpoints a definite area. In contrast to the general information provided by gross sales figures, the departmental data tells the manager not only what happened but where.

Knowing the area of trouble, the manager can now direct his atten­tion to the proper revenue producing department and discover the cause for drop in sales. Did sales drop in the food department because of poor quality food, a change in menu prices, poor service, inade­quate promotion? Now that we know where to look, we can find what the trouble is and eliminate it.

Departmental Productivity

To determine the relative productivity of each revenue producing department is also very simple with this type statement. The total columns point out that up to this time in the current accounting period the food department has accounted for 75 percent of the gross sales; the bar, 23 percent of gross sales and other sales were less than 2 per­cent. The cost-of-sales section in the to-date columns reports that in order to obtain $100 worth of sales, the food department spent $41 for food, the bar only $29 for liquor and the "other" revenue producing departments $50. Stated simply, for every $100 sales the food depart­ment contributed $59 to the gross profit, the bar $71 and the "other" revenue producing department only $50.

The figures become even more practical and interesting when the direct labor cost of each department is added to their respective cost of sales. For every $100 sales, after cost of sales and labor are deducted, the food department contributed only $40 to pay for other expenses, the bar $61 and the "other" revenue producing department only $27.50. The bar is obviously the most productive and the "other" reve­nue producing department the least.

The cost of sales figures in the February and January columns em­phasize the importance of the bar to gross profit. Although bar cost for February was 2 percent higher than January, an 11 percent increase in sales resulted in an additional $520 bar contribution to gross profit —almost 21 percent higher than its previous base.

Each restaurateur has his own ideas on policy formulation. One may want to emphasize food sales and another to emphasize liquor sales. Whatever the case may be, the comparative operating statement points out that if promotional costs are the same for both the restaurant and the bar, the gross return on advertising expense necessary to create an additional $100 sales is $40 from food sales and $61 from bar sales.

Gross Profit

Although a $1,500 decrease in sales was recorded in February, the gross profit percentage figure shows an increase of 1.8 percent. Gen­erally, the reverse is true—as sales decrease, expenses increase. What happened in this operation that created an increase in potential profit? Was it due to the manager's ability? Was it caused by a shift in sales? If the cause for the increase is determinate, we may be able to dupli­cate the condition again.

Since gross profit is the deduction of cost of sales from sales, an analysis of changes in gross profit involves an analysis of changes in sales and in cost of sales. In this case, February food sales were $30,000 and food cost was 40 percent or $12,000. If the manager had not actively intervened, the food cost percentage for February would have been 42 percent or $12,600. One reason for the percent­age increase of gross profit therefore is the additional $600 saved from cost of food.

February's bar sales increased $1,000 over January and bar cost rose to 30 percent during the same period. The bar sales and cost figures show, however, that the net bar contribution to gross profit in January was only $6,480 compared to the $7,000 contribution made in February. Consequently, gross profit was increased by $520.

Departmental Performance Standards

The calculations above bring us close to a subject dear to the hearts of many competent restaurant operators—the establishment and main­tenance of proper departmental standards. On the basis of the operat­ing statement shown, for example, what should the food cost percent­age be? As an owner, should we ask the manager to maintain a 40 per cent food cost, a 42 per cent food cost, or take the average of 41 %?

Closer study of the profit and loss statement shows that during Feb­ruary when food costs were 42 per cent, sales were $32,000. In Jan­uary, however, a 40 per cent food cost grossed only $30,000 food sales. Is this information significant? Which is better for the operation, $32,000 sales volume at 42 per cent or a $30,000 volume? Dollar-wise, the 42 per cent cost contributes $18,560 to gross profit and the 40 per cent cost contributes only $18,000, a difference of $560 a month.

The problem of determining the proper standard, therefore, is to determine what caused the decrease in sales. Did food sales drop be­cause there was a change in menu pricing, a shift from larger to smaller portions, a change in quality? Almost anyone can reduce costs in this manner. The wise owner, however, concentrates on reducing costs but maintaining or increasing sales. It is possible for an operation to have a 10 per cent food cost. However, what good is a low food cost percentage if there are no customers?

Looking at the statement, we can't say that food sales dropped be­cause of local economic conditions. Why did the sale of liquor in­crease? In any event a standard cannot be determined until the cause for sales decrease has been discovered. If a 40 per cent food cost was the result of elimination of theft, poor purchasing, receiving, prepara­tion habits, perhaps the 40 per cent food cost can be made a standard for the department. However, if a lower food cost means poorer qual­ity food, smaller portions, higher prices, the 42 per cent is a much better standard.

Bar Standards

The bar figures present an interesting contrast to the food figures. As the cost of the liquor sold rose from 28 per cent in January to 30 per cent in February, sales volume increased from $9,000 to $10,000. Dollar-wise this rise in sales accounts for an additional $520 contribu­tion to gross profit. Two per cent rise in liquor cost is equivalent to $200 extra cost on the basis of $10,000 sales volume. Perhaps it is wise to serve better drinks at a lower price, thereby increasing costs $200 if we can also increase gross profit $520. Only a detailed exami­nation of the cause for sales increase can aid us in determining the proper bar cost percentage.

Payroll Standards

The direct labor costs of the food department presents no particular problem in this case. If, during the month of January, the food depart­ment could prepare and serve $32,000 worth of food with a direct labor cost of 18 per cent, and if, during that time, there were no guest complaints regarding service or food, there is no reason why this department could not serve 30,000 at approximately the same per­centage.

In justification to the manager's efforts, mention should be made that he evidently did reduce the dollar amount of his payroll. As sales decreased during the month of February, he reduced his payroll by $760. True, this is 20 per cent of food sales. However, if he did abso­lutely nothing, the payroll percentage would have been 22V^ per cent.

This is one of the cost areas that creates a particular problem to the sophisticated operator. It is difficult to set a standard for all levels of sales. The problem of performance determination is complicated not only because of the amount of sales aids in setting equitable standards but also because the direction of sales is a determining factor.

If sales increase, the labor cost percentage should go down, if for no other reason than the fact that all the employees in a restaurant are working at maximum productivity most of the time. On the other hand, as sales decrease, the alert operator can change time off, stagger schedules, split shifts, employ part-time help, dismiss other employees, yet invariably if he was operating at peak levels, labor cost cannot decrease in identically the same proportion as sales. Consequently, if an 18 per cent direct labor cost is determined as the proper performance standard for the food department, the manager will find it relatively easy to maintain this percentage if sales are moving upward and ex­tremely difficult to maintain if sales move downward. In the first instance, with sales volume increasing, we are giving the manager undue credit for maitaining the "status quo" and in the second case not enough credit for almost perfect performance.

Ideally, with young growing operations not one, but several, per­formance standards should be determined for each significant change in sales volume. If the standards are determined correctly, they become a major tool of management and an invaluable aid to the owner in forecasting and budgeting future labor expense.

Percentages

A blanket percentage figure such as 30 per cent labor cost for the entire operation is generally useless as a management tool. A blanket percentage figure tells what happened but does not tell who created the cost, was it necessary, where was the cost incurred.

Notice that percentages alone do not tell the entire story. Percentage data must be compared to the dollar value. In the food department's payroll, for example, the labor cost percentage shows a rise of two per cent. However, when these are compared with the dollar value of the payroll, the manager effected a savings of $760.

Several items on the statement do not have percentage values. The reason for this omission is to illustrate that any percentage figure used must be of value to management. If a manager cannot use the infor­mation, there isn't much sense of incurring expense to accumulate data that is not or cannot be used to tighten the control of the opera­tion.

For this reason, also, several percentage figures shown were not carried out to the last decimal point. Why should any figure including percentages always total 100 per cent? What good does it do manage­ment to know that a certain expense varied one hundredth of a per­centage point?

The percentage figures shown in the scheduled expense columns are also meaningless from a comparative standpoint. Since all of the ex­penses are fixed dollar-wise, a percentage fluctuation of 100 per cent is indicative of a sales volume increase or decrease, not a fluctuation in cost.

Management Index of Effectiveness

This statement is deliberately designed to record and emphasize those costs that can and should be controlled by competent manage­ment. In addition to the item, cost of sales, all expenses listed under the heading Controlled Expenses can be controlled and should be the main responsibility of the manager. His effectiveness in operating a food service operation can be measured accurately and definitely in direct proportion to his ability in increasing his sales and reducing the cost of sales or any excessively high controllable expense.

Below the controlled expense category are scheduled expenses. This classification includes all expenses that, because of some law or prior agreement with outside agencies such as local and state governments, banks and landlords, are relatively fixed and predeterminable. The time to consider these expenses is before they are incurred. After a law has passed or a ruling has been made regarding valuation of real property, licenses, taxes; or when an agreement is reached concerning the amount of rent, depreciation, insurance, or interest expense, the cost passes beyond the immediate control of the operating manager.

The immediate value of this classification is that any owner can glance at his statement and know instantly how productive he or his manager is. Without this classification of expense the costs that are a manager's responsibility are distributed over the entire profit and loss statement. With the customary format one item of cost is pointed out at a time and then another cost is located and discussed. This is not only time consuming but indicates disorganization and faulty cost distribution.

A profit and loss statement should not only dramatically emphasize those costs that are the manager's responsibility but also provide him with an accurate index of his ability as the operating head of his unit. The classification of expenses as shown in the illustrated operat­ing statement will achieve both those objectives.

The most significant features of the operating statement are not that they provide a record of sales and costs—more important than this is the fact that the sales and costs have been pinpointed, sum­marized in a single, easily comprehensible digest for evaluation and spotlighted as the sole responsibility of the operating manager.

Once the competent operating manager realizes that these records provide the owners with a comprehensive index of his ability and make him solely responsible for abnormal fluctuations in sales, food, labor, and other controllable costs, he will use these statements as valuable, additional tools to increase his efficiency and to assure the success of the food service operation.

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