Today we are talking about profit centers or in other words what really makes up your bottom line.

Most businesses have many different units.  They may be different offices that all do the same thing or they may be completely different businesses that share the same room.  Your profit center could be an employee, an office, a state, or a product line.  You may call it something completely different in your business.

A backhoe is an example of a piece of equipment that could make up a profit center. It may be a piece of equipment that you rent out or it may be a piece of equipment that you use on fixed fee construction job.  The backhoe has maintenance costs. It needs to get an oil change now and again. It uses gas, it gets dinged up and needs to be fixed.  A backhoe may also have revenue directly associated to it. If it’s a rental, then it is the amount brought in per hour for the number of hours it is rented. It is used on a job then it’s the revenue from the job that gets billed related to the work done by the backhoe.

If you take the time to break out your revenue and costs into that level of detail and tie them together you can see how much money a single backhoe made you or lost you?

Yes, either way, you want to know. If one back hoe is broken all of the time and costing you so much money in repairs and down time, then you need to sell it or bury it in the backyard.

Either way, you don’t want to take care of it and keep milking it along. If you were to lump it all together with all of the other pieces of equipment and not keep it separate from the new backhoes there is no way to realize that it is costing you money.

Once you realize that it’s costing you money to run a bad piece of equipment, you need to stop. Even if you don’t have the capital to buy a new replacement backhoe, you are still more profitable to decommission it.

Speaking of decommission or being decommissioned, let’s talk about beer.  Bottled beer is an example of a product line. If may be very helpful to compare your sales and costs of bottled beer to non-bottled beer.  By non-bottled beer, do you mean kegs of beer?  Yes, kegs of beer, but also cases of beer. Or you could be comparing bottle beer vs. bottles of wine or vs. bottles of liquor. The different product lines, even when closely related often have different customers. For example, bottled beer is typically sold to the end consumer.

In the case of single bottles of beer the consumer may be the person drinking the beer however, non-bottled beer, (i.e. kegs and cases of beer) are typically sold to restaurants and hotels. Having the different types of beer separated as different product lines can provide you with a great deal of information. Information that can affect your marketing, the amount of inventory you hold, where you hold it, etc. etc.

Well, I know most everyone already gets sales reports by product line. What would a report for profit center look like and how does it differ from sales reports that most decision makers may already be looking at?

Well, a sales report is as simple as it sounds. It’s just the sales part, it’s just the revenue part. It’s helpful, it’s meaningful, it’s an absolute requirement, but it is not the entire picture. By adding in the cost side of the equation and matching up the associated revenues and costs you can get a more accurate picture of the success or failure of each product line. What you get is a net income statement for each individual profit center.  A net income statement by profit center can bring a great deal of insight into the detail of what is happening.

For example, we worked with an insurance company that sold two different types of insurance. They sold automobile insurance and life insurance. If they only looked at the revenue you could see that they had combined revenue for the two insurance lines of $100M. Sales between the two lines were split just about 50/50. So, $50M in annual sales for auto insurance and $50M in sales for life insurance. They paid out annual claims of $75M dollars. It’s easy to see that they were a successful business when you look at the business in its entirety.

When we helped them break down their company into profit centers, we matched the claims to the insurance type and discovered they paid out nearly $50M in car insurance claims, but only $25M in life insurance claims.  Armed with that knowledge it’s easy for the decision maker to improve the overall bottom line. Even if it is not close the auto insurance division completely, it is certainly to focus future resources on life insurance.

The industry may dictate that they need to sell the customer auto insurance to get them to buy life insurance, so they may need to keep it. Well, if that’s the case, you at least know that you need to keep claims down for auto insurance. May be that mean discounts for drivers that go for extra training or different requirements for the type of customers that you accept.

Or maybe a change in rate structure?

You may have your customer pay $25 to get do safe driver school in exchange for reducing their premium. Which in turn will have a bigger effect on the claims filed.  Yes, yes, any of those things. It gets pretty easy to make changes that will have a huge impact on your bottom line… once you have the facts.

Do you want to talk about the building on the beach in South Florida now?  Sure, the building in South Florida is just an example of a location.  That location could be one of many sales centers, services centers, or stores that all do the same thing.  Looking at each office building as its own separate company that it profitable or not profitable all on its is the best way to compare your winners and losers.

How do we track this? GL Segments/Reports//etc…

One of the easiest ways to track a profit center would be to use your chart of accounts and create what we call segments. These segments would represent the profit center and allow you to allocate both revenue and cost to the profit center. Let’s take a look at a revenue account. Using our beer example, GL account 4000 might represent sales of alcoholic beverages. By adding segments to that account, you can track additional detail.

4000-1 = Beer Sales
4000-1-10 – Bottled Beer
4000-1-20 – Case Beer
4000-1-30 – Keg Beer

4000-2 = Wine Sales etc…

Same goes for the cost of sales accounts, where 5000 might be the cost of sales account.

I’m thinking about our insurance example again. In addition to their claims, the next biggest cost they have is the building. The only have one building. One building that comes with one power bill and one rental cost. Can you talk for a minute about how that gets split over the two profit centers that we discussed? The one for auto insurance and the one for life insurance.  Sure, we helped them setup an allocation. In this case it was based on square footage because it was a building, but it could have been the number of employees in each department or the number of insurance policies.

We get that setting this up takes some work and that tracking to the level of detail required some discipline, but we have found it is well worth the effort, time and expense. Often, the majority of the work can be dealt with through automation in the accounting system. If the system setup correctly and the report are designed with answering these questions in mind, a lot it can just happen automagically every month.

So, think about this some more. Think about the level of detail that you get your net income statement in. Think about the things that you don’t know that you wish you did. Please feel free to leave us a comment or a question. We always enjoy feedback.

Thanks for reading.