As we are all aware by now, the current economy is not great. Accordingly, your sales are probably not what you would like them to be. Similarly, your expenses are also probably not what you would like them to be. If your sales and gross profits are declining, are your total expenses decreasing proportionately? If not, it’s time to review your income statement. Print your income statement in a format with the last 12 months side-by-side in detail by account. Once you have this report, preferably in Excel format, you can compare your sales, cost of sales, gross profits and expenses by month to determine the trend. You can insert additional columns between the months so you can calculate the gross profit percentages by month to determine if your sales categories, as a percentage of total sales, have changed dramatically. Your expenses should be reflected as a percentage of sales or gross profits.
Now that you have the above data calculated and reviewed, move on to your total expenses. There are different types of expenses. The first type is selling, or variable, expenses. These expenses are amounts which are directly related to sales and inventory carrying costs, such as sales salaries and commissions, advertising, and floor plan interest expense. These expenses should change proportionately to your sales and gross profits with small variations. If you are overstocked on inventory both before and after your month in question, then floor plan interest expense may still be high even though your sales are consistent.
If sales commissions are higher as a percentage of sales or gross profits, this could indicate you paid more spiffs than normal or your average gross profits are lower than normal and you paid out some minimum commissions as a guarantee to your sales people.
Advertising is normally an expense that is decided upon before any sales are created, whereas commissions are paid after the sale. Since advertising dollars are spent in anticipation of future sales, hopefully they create enough sales to pay for the expense. If they don’t create enough sales, then advertising expense as a percentage of sales or gross profit will be higher.
The next type of expense is operating, or fixed, expenses. These expenses tend not to change in relation to sales or gross profits. Some examples of these are clerical salaries, dealer salaries, rent, utilities, insurance, payroll taxes, outside services, telephone, real estate taxes, supplies, depreciation and repairs. If sales and gross profits decrease, then these expenses will be higher as a percentage of sales and grosses. This is normal. To achieve lower fixed expenses, you can review the detail transactions that make up these expenses. Are any of them controllable? You can put off additional expenditures that are occasional or are not required every month.
Check to see if these expenses remain somewhat consistent each month. If they don’t, then maybe they are not being recorded on an accrual basis consistently each month. When reviewing the detail activity, see if there is more than one month’s expenses in one month and none in a following month. If you see this, review how and when the invoices are recorded. If you don’t receive an invoice to record before you close the month-end books, you can always accrue for the estimated expense. You can adjust the accounts payable or accrual to reflect any change from the estimated amount to the actual amount the following month.
Examples of expenses that are normally accrued each month are real estate taxes, legal and accounting fees, and insurance. You should record an estimate each month equal to one-twelfth of the total annual cost. When you pay the bill, you would not charge it to expense, but to the accrual account for that expense. If you charge it to expense and have accrued for it each month, then you will have doubled your expense for the year and probably show a huge expense in one month as compared to the other 11 months.
There are other expenses that require “standard entries” to be posted each month. These are similar to accruals, but some do not require a payment of cash. Depreciation and amortization expense are good examples of these. They are expenses that do not require a cash outlay and normally decrease an asset on your financial statements over time. These expenses normally decrease a long-term asset, such as property and equipment or organization expense.
Prepaid expenses are expenses that cash has been paid out for a future period’s expense. They require cash to be paid in advance, sometimes in a month where there may be no related expense, but then expensed in future months similar to depreciation expense. These expenses normally decrease a current type of asset, such as prepaid insurance, taxes and advertising.
After reviewing the detail activity of your expenses and the percentage of each expense to sales, various expenses may stand out as abnormal. Sometimes the expense as a percentage of sales or gross profit will look extremely high. The increase in this expense may still be normal because the dollar amount is small compared to the percentage change from one month to another.
In conclusion, if your fixed expenses are not consistent each month, you may have an accounting procedure you need to correct. If some show a higher or lower percent of sales, the dollars spent may still be in line. If your variable or selling expenses aren’t somewhat proportional to your sales, maybe you are overspending in areas that are not generating sales and gross profits like they should.
Remember to review your expense activity each month and compare it to prior months. This is the easiest way to help control expenses and know what your breakeven units and grosses need to be to make a profit. Also, remember to look at both the percentage and the dollars, as one or both can be distorted in relation to sales or gross profits.
Vol 5, Issue 1
