Number Games
July 2, 2009, 4:05 pm
Copyright © 2009 Integrated Profitability TM
Any blog on finance and profitability must deal with numbers. Which can be tedious and boring. One of the main points behind the “Small Business Finance & Profitability” is that owners and other stakeholders in the business need to actively understand those numbers: which are reporting the direction and health of your business. You can hire others to do the tedious chores, as long as you hire trustworthy and conscientious people. But what can never be sub-contracted, at least not without major risk, is the knowledge of what the numbers are telling you.
An earlier blog, “Numbers People,” provided an introduction to types of jobs and careers that are involved with company numbers. At the end, it was stated that some functions should be separated to some extent as a matter of prudent “checks & balances.”
Here’s an example from a large company. Let’s say the company is experiencing a squeeze on profitability because of a very tough market. Sort of like the one we are in right now. Further, a mandate comes down from management that the whole company has to cut expenses. Let’s also say that, for this particular industry, companies routinely pay for certain market services on behalf of their customers, who later reimburse the company (e.g., armored car expenses; shipping costs). And, finally, these types of reimbursements (i.e., money received from customers) have been booked as revenue (although accounting for them as offsets to expense is an accepted treatment—in other words, there are two legitimate ways to handle this type of activity).
Now imagine two departments responding to the company-wide cost-cutting mandate. One department slashes away at all non-essential expenses. The other one simply changes the accounting rules and starts booking the customer reimbursements as “negative expenses.” Even worse, the reimbursements are booked to the same accounting line as the original expenses so that standard financial reports only show the net amount (i.e., original expense paid to service provider less reimbursement from the customer).
The financial reports for both departments will look like their expenses are going down. But only the first department is helping the company.
If the expenses are material enough, a good financial analyst will spot the subterfuge because the two departments’ revenue and net-profit would be different. The one actually cutting costs will look better on both lines, compared to the one that only changed the accounting treatment.
Reporting Prior to Expense Reduction Mandate
|
Department 1 |
Department 2 |
Diff ($) |
|
| Revenue |
100 |
100 |
0 |
| Customer Reimbursements |
10 |
10 |
0 |
|
Total Revenue |
110 |
110 |
0 |
|
|
|
|
|
|
Expenses |
80 |
80 |
0 |
|
|
|
|
|
|
Net Profit |
30 |
30 |
0 |
Reporting After Expense Reduction Mandate
|
Department 1 |
Department 2 |
Diff ($) |
|
| Revenue |
100 |
100 |
0 |
| Customer Reimbursements |
10 |
|
-10 |
|
Total Revenue |
110 |
100 |
-10 |
|
|
|
|
|
| Expenses |
80 |
80 |
0 |
| Real Expense cut |
-10 |
0 |
|
| Accounting change |
|
-10 |
|
|
Total Expense |
70 |
70 |
0 |
|
|
|
|
|
|
Net Profit |
40 |
30 |
-10 |
Perhaps the departments are cost centers and are not directly linked to revenue. In the best case, the issue will take time to be caught. In the worst case, it will go unnoticed.
In certain situations, letting finance control accounting is like letting the fox run the hen house. You need accountants in a position to point out that certain practices, while legitimate, are obscuring what is really going on with a company’s profit.
As for accountants controlling finance? A relevant analogy is a harder to imagine, but perhaps it would be like wrapping an oak sapling in chicken wire. Times do change and everything, including the rigorous controls of accounting, also needs to evolve: as the current financial and economic situations pounding the US and world economies for the last two years amply show.
Know your numbers, and how people are reporting them to you.
Bill
William A. Stong
Email: william.a.stong@gmail.com
SBF&P # 26
Copyright © 2009 Integrated Profitability TM
Subscribe to our blogs using either our 
Following that up with “Number Games” was good and I liked the sample reporting grids you included. However, I had some trouble relating the narrative to the example. It seems to me that the Real Expenses Cut and Accounting Change lines are, in their nature, different from the other lines in the matrix. The former is more like a footnote to the Expenses line above it which should be 70, not 80; the -10 is the notional result of reducing the Expenses by
10%. The latter would make more sense to me if it were labeled something like Offset to
Expenses.
Do your plans for the blog include a simple but meaningful scenario which you’d have the
three Numbers People work through to posting, reporting and interpretation and planning?
That could certainly be used to fill any number of separate blog postings and, though it
might be boring for you to write, it would probably be useful to anyone who had not been
a Business Major be useful.