Ways to look at your company profitability.

Profitability is obviously looked at through the company consolidated statutory figures and in the focus of both CFO and company management board. Yet, if it gives an essential view for the company as a whole, it does not explain the profitability build up in details.

Understanding the build up means far more detailed profitability analysis: “specific P&L’s”.

Which specific P&L?

Dependant on type of business/company, it may be more relevant to have a set of P&L’s

· per product/product line,

· per project,

· per production centre,

· per customer/customer type,

· Per region/country.

Complex conglomerates may need a mix of those different types or P&L’s that mix some of those dimensions (e.g. customer per product lines P&L’s or product lines per region/country) whereas more specialised company may only need one or a limited number of specific P&L’s types.

Face the challenges!

Those “Specific P&L” brings several challenges to the finance community. Whereas the rules for statutory accounts are well established, those specific P&L are generally tailor made in each organisation. Even the reconciliation that the total of all P&L of a given type (e.g. product P&L’s) equal to the total statutory accounts may bring some challenges but remain fundamental.

Whereas Revenues and direct cost of sales (variable costs) may be more or less straight forward (provided the data structures and processes are correctly organised), the other costs distributions are generally far more challenging.

Needless to say, strong data management in ALL functions is a key pre-requisite. Not just the data that will impacts the financial flows but also all the statistical quantitative and qualitative data (e.g. Usage or activity ratios, defects or other none quality costs, volume versus prices, etc…). This is essential to built confidence in the results.

Margins or profit?

Choosing a level of margin to reconcile specific to statutory figures is most probably the way. As long as there is a strong and consistent way to reconcile the specifics and the statutory, I would advocate that it shall be a company choice based on the potential added value of bringing some costs within the distribution mechanism. It is more effective to demand a higher level of margin rather than adding costs level that are not directly relevant to the concerned managers. At end those P&L’s shall permit to take actions when necessary, polluting them by costs layers on which the line management have no control may not be the most efficient way.

The periodicity of such P&L’s is dependant on business, more specifically on the way things changes in the specific markets. Quarterly is a good way to start with.

FP&A role is critical in those areas.

Specific P&Ls are extremely effective tools that play a fundamental role in creating true added value to the business. They explain how the overall picture is achieved and will permit specific action plans that are far more effective than the traditional top-level cost cutting. Still, this is only achieved through a good level of confidence in the figures.

FP&A role is then essential in the building up and understanding of these P&L’s, in the explanation to business and in actively designing corrective/improvement plan with the business whereas necessary. It shall permit to understand the key elements that are impacting the profitability such as:

· Revenues prices versus volume variances (including currency impacts when relevant). It could be products specific or customers specific or a mix.

· Variable costs prices and volume variance (including currency impacts when relevant)

· Impacts of the activity level on the fixed cost allocations (in details).

· Impacts of none quality,

· …

Detailed profitability analysis is a tremendous help in improving forecast, pricing and actuals thanks to a more detailed understanding of the overall profit genesis.

More complete article published in FP&A trends https://www.fpa-trends.com/article/fpa-and-profitability.