chapter 14 Income Statements and Budgets Class Name

chapter 14 Income Statements and Budgets Class Name Instructor Name Date, Semester Foundations of Cost Control Daniel Traster

Income Statement Disclaimer • The National Restaurant Association’s Uniform System of Accounts for Restaurants describes an industry standard format for income statements, so businesses can compare their data to other businesses • The income statement format described here is NOT the NRA approach, but a similar, simplified version that is easier to learn and that makes a transition to the NRA format easier as well. • The NRA version is described in the appendix. 2

Three Financial Reports Balance Sheet • reports company’s assets, liabilities, and equity Statement of Cash Flows • depicts movement of cash through a business Income Statement • overview of business’s revenue, expenses, and profit (and the focus of the chapter) 3

Income Statement Format • Can be written to cover any time period • Common Size Income Statement lists dollars and percents for each line item and category • Percents express each line item as a percent of sales, except for the subheadings under “Cost of Sales” 4

Figure 14 a: Portion of Common Size Income Statement Total Sales $375, 400 100. 0% Salaries and Wages $110, 380 29. 4% Employee Benefits $24, 838 6. 6% $135, 218 36. 0% Labor Total Labor Cost 5

Income Statement Format (cont. ) • Always start with a “Sales” category, which is subdivided into “food” and “beverage” sales • Percents for food and beverage sales show the sales mix between food and beverage • Total sales always equals 100% 6

Income Statement Format (cont. ) Subcategories under “cost of sales” use different percent bases (not based on total sales) Food Cost % Food Cost Food Sales 7

Income Statement Format (cont. ) Beverage Cost % Beverage Cost Beverage Sales 8

Income Statement Format (cont. ) Total Cost of Goods Sold Sum of Food and Beverage Costs (variable) 9

Income Statement Format (cont. ) Gross Profit Money left from sales after total cost of goods sold is deducted 10

Figure 14 b: Portion of Common Size Income Statement Sales Food $727, 194 74. 0% Beverage $255, 561 26. 0% Total Sales $982, 755 100. 0% Food Cost $255, 180 31. 0% (% of food sales) Beverage Cost $58, 804 23. 0% (% of beverage sales) Cost of Sales Total Cost of Goods Sold $283, 984 28. 9% Gross Profit 71. 1% $698, 771 11

Income Statement Format (cont. ) Labor • cost for employees, both earnings and benefits • Semi-variable cost Salaries and Wages • labor’s income Employee Benefits i • cost of benefits Prime Cost • sum of total cost of goods sold and total labor cost 12

Figure 14 c: Portion of Common Size Income Statement Labor Salaries and Wages $275, 442 28. 0% Employee Benefits $52, 155 5. 3% Total Labor Cost $327, 597 33. 3% Prime Cost $611, 581 62. 2% 13

Income Statement Format (cont. ) Controllable Expenses • all other semi-variable costs Direct Operating Expenses • cost for items other than food and drink that go toward serving customers and that are not covered in other controllable expense categories. (Flowers, china, menus, uniforms, laundry, cleaning supplies, etc. ) 14

Income Statement Format (cont. ) Music and Entertainment • license fees and royalties, performer fees and food, equipment for entertainment Marketing • costs for all marketing activities (advertising, PR, comp meals, etc. ) Utilities • costs for gas, water, electric, and waste removal 15

Income Statement Format (cont. ) General and Administrative • costs for infrastructure required in any business (telephone, internet, insurance, office supplies, etc. ) Repair and Maintenance • cost for all equipment and facility repairs and maintenance 16

Income Statement Format (cont. ) Total Controllable Expenses • sum of all controllable expenses Income before Fixed Costs • Equals: • Total Sales – Prime Cost – Total Controllable Expenses • In other words, income before fixed costs is the amount left to cover fixed costs and profit 17

Figure 14 d: Portion of Common Size Income Statement Controllable Expenses Direct Operating Expenses $48, 506 4. 9% Music and Entertainment $14, 300 1. 5% Marketing $19, 325 2. 0% Utilities $38, 992 4. 0% General and Administrative $24, 774 2. 5% Repairs and Maintenance $14, 500 1. 5% Total Controllable Expenses $160, 397 16. 3% Income before Fixed Costs $210, 777 21. 4% 18

Income Statement Format (cont. ) Fixed Costs includes 3 major categories: Occupancy Costs rent, property taxes, property insurance Interest cost of using someone else’s money; like interest paid to a bank for a loan Depreciation an accounting device used to spread a significant cost across multiple years based on the life expectancy of the purchased item (large equipment or renovations) 19

Income Statement Format (cont. ) Total Fixed Costs • sum of all fixed costs Profit before Taxes • income before fixed costs – total fixed costs • From pre-tax profit, income tax and profit are determined 20

Figure 14 e: Portion of Common Size Income Statement Fixed Costs Occupancy Costs $98, 800 10. 0% Interest $28, 746 2. 9% Depreciation $31, 678 3. 2% Total Fixed Costs $159, 224 16. 2% Profit before Taxes $51, 553 5. 2% Income Taxes $12, 213 1. 2% Net Income $39, 340 4. 0% 21

Income Statement Graphic Formula • % column is calculated using the graphic below Cost • For food cost and beverage cost, “sales” is the corresponding food sales or beverage sales; all other items use “total sales” for sales. Sales x % 22

Example 14 a On income statement, “marketing” is listed as $7, 000. Total sales are $380, 000. What percent should be written next to “marketing”? % = Cost ÷ Sales = $7, 000 ÷ $380, 000 = 1. 8% 23

Example 14 b Income statement lists food sales as $114, 600. Manager wants to run a 30. 4% food cost. What should food cost be in dollars? Food Cost = Food Sales X % = $114, 600 X 0. 304 = $34, 838 24

Comparing Income Statements and Budgets Income Statements vs. Budgets • Income statements and budgets look similar • Same line item names and common size format • Income statements use real data from history • Budget is forward-looking plan • Both are often compared side-by-side • Two approaches to compare them: common size analysis and comparative analysis 25

Common Size Analysis 1. Calculate difference between the two percent columns on each budget/income statement line item. 2. Variance = income statement percent – budget percent. (Or, if comparing 2 income statements, the new statement’s percent – older statement’s percent) Note: Since total sales are always 100%, their variance will always be zero. Look at sales dollars separately. 26

Figure 14 f: Common Size Analysis Budget 1/1/1112/31/11 Budget Actual 1/1/1112/31/11 Actual Variance Food $750, 000 75. 0% $727, 194 74. 0% (1. 0) Beverage $250, 000 25. 0% $255, 561 26. 0% 1. 0 $982, 755 100. 0% 0 Sales Total Sales $1, 000 100. 0% 27

Variances • Management determines acceptable variance range in advance. • Management must decide what to do about unacceptable variances • Options include: ―controlling costs ―boosting revenue through marketing ―or adjusting the budget • If figures beat expectations without sacrificing business standards, changing the budget may be appropriate 28

Comparative Analysis 1. Calculate the difference (variance) in dollars between the line items in two periods as follows: variance = newer dollars – older (or budget) dollars 2. Convert the dollar difference into a percent change as follows: Dollar variance % = Earlier time period (or budget) dollars 29

Comparative Analysis (cont. ) • Great for determining trends • Identifies how well dollar figures align with the budgeted dollar figures • Does not highlight problems that occur when managers fail to adjust their expenses to reflect shifts in revenue 30

Figure 14 g: Comparative Analysis Budget 1/1/1112/31/11 Actual 1/1/11 - Variance $ 12/31/11 Variance % Food $750, 000 $727, 194 ($22, 806) (3. 0%) Beverage $250, 000 $255, 561 $5, 561 2. 2% $1, 000 $982, 755 ($17, 245) (1. 7%) Sales Total Sales 31

Why Comparative vs. Common Size Analysis? Comparative vs. Common Size • Comparative provides dollar differences as well as percent variances • Comparative highlights differences in small value line items better • Comparative shows trends for future budgeting • Common Size better highlights changes management should have made when revenue misses its target • Best to perform both types of analysis 32

Creating a Budget • Budget must be realistic to have any value • Goals of a budget: 1. 2. Predict revenue and expenses accurately Set aggressive targets for managers to hit • Accuracy gives managers a road map to use • Aggressive targets push everyone to be a little more efficient 33

Why Front-Line Workers Should Care about Profits • Greater profits lead to stable company and better job security • Large profits can lead to expansion, raises, and promotions • With profits, owner may invest in facility to improve working conditions 34

Prior to Writing a Budget Research historical data and trends for the business. Investigate upcoming internal and external variables that may impact future budgets. Set budget goals based on information collected and the owner’s and management team’s desires. 35

Historical Data is the starting point for the next budget. • Usually comes from POS • Include: ―check average ―customer counts ―expense patterns and trends (in $ and %) ―income statements over multiple years 36

Internal and External Variables are used to identify changes from prior trends. Internal External come from outside the business. • new equipment • new competitor • menu changes • closure of local business • spikes in food prices External learned from trade publications, professional associations, news reports, customers and purveyors 37

Setting Budget Goals • Management team sets goals for revenue growth and expense percents • Must be realistic, achievable, and based somewhat on historical data and internal/external variables • Do not have to match forecasts exactly 38

Example 14 c Total sales on income statement were $700, 000. Management wants 5% increase in sales next year. What is next year’s total sales budget? New amt = old amt. X (1 + % change) = $700, 000 X (1 + 0. 05) = $735, 000 39

Example 14 d Management says “marketing” should be 4. 9% of sales. If total sales are budgeted at $735, 000, what is marketing budget? Cost = Sales X % = $735, 000 X 0. 049 = $36, 015 40

Example 14 e This year, repairs and maintenance is $17, 300. Management wants to cut this line item by 8%. What is next year’s budget for repairs and maintenance? New Cost = Old Cost X (1 + % change) = $17, 300 X (1 + (-0. 08)) = $17, 300 X 0. 92 = $15, 916 41

Example 14 f For next year, management knows rent will remain $4, 800 per month. Property taxes are increasing to $800 per month. Property insurance will be $630 per month. If these are the only components of occupancy cost, what is the monthly and annual budget for next year’s occupancy cost line? Monthly = $4, 800 + $630 = $6, 230 Annual = $6, 230 X 12 months = $74, 760 42

Planning for Profit If entering all sales and expense dollars, based on forecasts and management goals, into budget spreadsheet does not generate desired profit, management must adjust the expense lines to try to hit the profit target – unless the profit goal is unrealistic. 43

Planning for Profit (cont. ) • Changes to initial budget must be feasible for managers to achieve, or they will never materialize • Every change must come with a plan of action describing how the change will be managed in the realworld 44

Dividing a Budget into Smaller Time Frames • Easier to adjust daily work habits, schedules, and purchases to align with a budget if the budget is done in a smaller time frame • Using only annual budgets, managers may not catch problems until it is too late • Business fluctuates seasonally, so managers cannot just divide annual budget by 12 or 52 to get monthly or weekly versions 45

Dividing a Budget into Smaller Time Frames Historical data reveals the percent of annual revenue that is brought in each month, week, or day. Historical patterns are usually consistent from year to year. 46

Creating a Monthly Revenue Budget 1. List last year’s historical revenue per month and total annual revenue 2. Calculate percent revenue each month represents. Monthly sales % = Annual sales 3. Using next year’s annual sales forecast, calculate each month’s sales as: Annual Sales X % for a given month (from step 2) 47

Example 14 g In August last year, sales were $33, 300. Annual sales were $358, 000. If next year’s sales budget is $380, 000, what should August’s sales budget be? $33, 300 ÷ $358, 000 = 0. 093 or 9. 3% (August %) $380, 000 X 0. 093 = $35, 340 (August sales) 48

Calculating Monthly Budget • Management may adjust monthly percents slightly based on internal or external variables • From monthly sales, calculate monthly expenses: • Keep variable costs the same % of sales • Write fixed costs based on their payment schedule; may be evenly divided by month. 49

Calculating Monthly Budget (cont. ) • For semi-variable costs, separate the fixed and variable components. • Divide fixed components evenly over the year; keep variable components the same percent of sales. • With labor, factor in any planned pay increases • For expenses with an irregular payment schedule (e. g. , repairs and maintenance), schedule the payments for the appropriate months. 50

Calculating Shorter Time Frame Budgets • Use the same logic as for monthly budgets ―For weekly, compare the same week of the prior year (e. g. 32 nd week of the year) ―For daily, compare the same day of the week of the prior year (e. g. 2 nd Monday in April) • Always factor in any internal and external variables that may change sales percents • For weekly or daily budgets, fixed costs paid monthly may not be relevant, so remove them. 51

Example 14 h • Manager forecasts $800, 000 in annual sales next year. • Last year, June was 10. 2% of sales. • Budget forecasts cost of goods sold at 32. 5% of sales and annual occupancy costs of $80, 000. If occupancy costs are divided evenly over the year, calculate the June expense lines for cost of goods sold and for occupancy costs. 52

Example 14 h (cont. ) June sales = $800, 000 X 0. 102 = $81, 600 COGS = $81, 600 X 0. 325 = $26, 520 Occupancy = $80, 000 ÷ 12 months = $6, 667 53

More on Shorter Budgets • Profit % may not match annual % because sales dollars fluctuate seasonally but fixed costs do not. • Can create daily budgets for every ingredient, employee, etc. , but unless manager incorporates them into daily control processes, they become a waste of time • Manager should compare weekly schedule to weekly budget to try to stay on budget; chef can do the same for weekly food orders • If weekly revenue targets are missed, management may need to shift marketing strategies or adjust expense budgets 54

More on Shorter Budgets • Making changes weekly rather than waiting a full year allows managers plenty of time to change course to maintain profit • It is possible to create weekly budgets first (from guest forecasts and average check) and then to create monthly and annual budgets, but annual budgets must be adjusted for profit and then weekly budgets must be adjusted accordingly. 55

The Evaluation Cycle • Always evaluate budget’s accuracy and company’s adherence to budget guidelines • Variances can stem from poor controls or from poor forecasting and budgeting • Learning from mistakes, managers can improve forecasting and budgeting ability in the future 56