Peeling away the Layers of a Financial Statement to Provide Essential Advice

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Peeling away the Layers of a Financial Statement to Provide Essential Advice

Edward Mendlowitz, CPA,

Partner, WithumSmith+Brown, PC

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Edward Mendlowitz, CPA

▪ Partner with WithumSmith+Brown, PC

▪ One of Accounting Today’s 100 Most Influential People

▪ AICPA designations: PFS, ABV, CFF, CITP, CGMA

▪ MBA Professor at Fairleigh Dickinson University

▪ Author of 29 professional books

▪ Developer and presenter of over 350 CPE programs

▪ Admitted to practice before U.S. Tax Court

▪ On BottomLine/Personal panel of experts

▪ Practice management techniques have been reported on by The Wall Street Journal, Journal of Accountancy and many other publications

▪ Testified twice before House Ways and Means Committee on tax equity and reform

▪ Has been a Team Captain and performed peer reviews for over 60 CPA firms

▪ Best selling author at CPA Trendlines

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Introduction

▪ Like an onion, financial statements have many layers beneath the surface. This presentation illustrates how to peel apart the layers and get below the surface to provide clients with essential financial information

about their business that will offer them better control

and a better way to use the financial information that is

at their easy access.

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1 ^st look at financial statement

20X1 20X2 20X3 20X4

Sales 4,050,000 4,657,500 5,497,875

% increase 15.0% 18.0%

Cost of sales 2,750,625 3,009,656

% 59.1% 54.7%

Gross profit 1,906,875 2,488,219

% 40.9% 45.3%

Operating expenses

Overhead and admin expenses 1,348,200 1,415,610

Selling costs 501,525 648,101

Total 1,849,725 2,063,711

Net income 57,150 424,508

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2 ^nd look – added 2 years

20X1 20X2 20X3 20X4

Sales 3,600,000 4,050,000 4,657,500 5,497,875

% increase 12.5% 15.0% 18.0%

Cost of sales 2,370,000 2,542,500 2,750,625 3,009,656

% 65.8% 62.8% 59.1% 54.7%

Gross profit 1,230,000 1,507,500 1,906,875 2,488,219

% 34.2% 37.2% 40.9% 45.3%

Operating expenses

Overhead and admin expenses 1,200,000 1,284,000 1,348,200 1,415,610

Selling costs 330,000 400,500 501,525 648,101

Total 1,530,000 1,684,500 1,849,725 2,063,711

Net income or loss -300,000 -177,000 57,150 424,508

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3 ^rd look – separated

products

20X1 20X2 20X3 20X4

Product A

Sales 3,000,000 3,150,000 3,307,500 3,472,875

% increase 5.0% 5.0% 5.0%

Cost of sales 2,250,000 2,362,500 2,480,624 2,604,656

% 75.0% 75.0% 75.0% 75.0%

Gross profit 750,000 787,500 826,876 868,219

% 25.0% 25.0% 25.0% 25.0%

Operating expenses

Overhead and admin exp - allocated 1,000,000 998,667 957,417 894,207 Selling costs (7% of sales) 210,000 220,500 231,525 243,101

Total 1,210,000 1,219,167 1,188,942 1,137,308

Net income -460,000 -431,667 -362,066 -269,089

Product B

Sales 600,000 900,000 1,350,000 2,025,000

% increase 50.0% 50.0% 50.0%

Cost of sales 120,000 180,000 270,000 405,000

% 20.0% 20.0% 20.0% 20.0%

Gross profit 480,000 720,000 1,080,000 1,620,000

% 80.0% 80.0% 80.0% 80.0%

Operating expenses

Overhead and admin exp - allocated 200,000 285,333 390,783 521,403 Selling costs (20% of sales) 120,000 180,000 270,000 405,000

Total 320,000 465,333 660,783 926,403

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4 th – Pr od uct pr ofit con tribution

20X1 20X2 20X3 20X4

Product A

Gross profit 750,000 787,500 826,876 868,219

Less selling costs -210,000 -220,500 -231,525 -243,101 Profit contribution amount 540,000 567,000 595,351 625,118

Product B

Gross profit 480,000 720,000 1,080,000 1,620,000

Less selling costs -120,000 -180,000 -270,000 -405,000 Profit contribution amount 360,000 540,000 810,000 1,215,000

Entire company

Total profit contribution 900,000 1,107,000 1,405,351 1,840,118 Less Overhead and admin expenses -1,200,000 -1,284,000 -1,348,200 -1,415,610

Net income -300,000 -177,000 57,151 424,508

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Question:

Do you add value with every client interaction?

I believe each of the previous

layers when included, added

value to the client

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Sales graph

0 500,000 1,000,000 1,500,000 2,000,000 2,500,000 3,000,000 3,500,000 4,000,000

20X1 20X2 20X3 20X4

Sales graph

Product A Product B

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Sales graph

Same as previous slide but condensed narrower

0 500,000 1,000,000 1,500,000 2,000,000 2,500,000 3,000,000 3,500,000 4,000,000

20X1 20X2 20X3 20X4

Sales graph

Product A Product B

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Profit contribution graph

0 200,000 400,000 600,000 800,000 1,000,000 1,200,000 1,400,000

20X1 20X2 20X3 20X4

Profit Contribution

Product A Product B

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Question: Why not just show the 2 graphs?

0 500,000 1,000,000 1,500,000 2,000,000 2,500,000 3,000,000 3,500,000 4,000,000

20X1 20X2 20X3 20X4

Sales graph

Product A Product B

0 200,000 400,000 600,000 800,000 1,000,000 1,200,000 1,400,000

20X1 20X2 20X3 20X4

Profit Contribution

Product A Product B

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Year end cumulative % change

Tricky Trends (see discussion on next slide)

The high point was 5408 on Mar 10, 2000

*

The low point was 1108 on Oct 10, 2002

*

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Discussion of NASDAQ index

based on previous slide

▪ The index began 2000 at 4069. On March 10, 2000 the index closed at its all-time high to that point of 5408. That is an increase of 32.9% in less than 2½ months. It then plummeted to end 2000 at 2471. Its downward trend continued to a low point of 1108 on October 10, 2002 but closed that year at 1336.

▪ The trends are there, but because of the measurement dates that I used which were the last day of each year, the full extent of the major swings and changes are not indicated.

▪ Looking at the above graph it shows a high point at December 31, 1999 of 4069 while the high point was actually 2½ months later. Using the high of 5408 as the benchmark it took until early 2017 for that index to get back to where it was in 2000. Since then it kept going up, until it didn’t at the end of 2018.

▪ The same thing happened in 2009 where these indexes hit low points in March, but those are also not reflected in the charts. As an FYI, the Dow Jones Industrial Average on March 9, 2009 hit its low point of 6509 and from there it catapulted upward. Neither the 2008 or 2009 ending amounts come close to that 6509 amount.

▪ Takeaway: Make sure you understand fully what you are doing and that the right beginning point and appropriate intervals are used in any data you review.

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Get small

• Invoice size

• Shipments per order

• Order or shipping backlog

• Time to ship after order is received

• Inventory management

• Increasing or declining inventory

• dead or slow moving items

• Are the right items in inventory

• Time received after order is placed

• Hours worked per production employee

• Cost of employee benefits

A new tactic. The previous info was looking at the big picture – the Macro.

Now let’s look at the

Micro.

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Basic financial statement

STATEMENTS OF OPERATIONS

Base year 5 Years ago

This year to date (5 months)

This year to date Annualized

Gross sales 20,800,000 9,750,000 23,400,000

Less sales returns and allowances -800,000 -583,333 -1,400,000

Net sales 20,000,000 9,166,667 22,000,000

Did not include in rest of illustration

Cost of sales:

Inventory - beginning 1,350,000 1,725,000

Purchases 6,000,000 7,176,000

Payroll 2,538,000 3,045,000

Other variable items 2,662,000 2,675,000

Fixed items 2,912,000 2,970,240

Inventory - end -1,425,000 -1,925,000

Total cost of sales 14,037,000 15,666,240

Gross profit 5,963,000 6,333,760

29.82% 28.79%

Selling costs 2,700,000 3,216,000

General and administrative 2,295,000 2,733,600

Interest 180,000 180,000

Net income before taxes 788,000 204,160

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Sales details

SALES

This year to date

Annualized Comments

Net sales 20,000,000 22,000,000

% change from base year 10.00%

# invoices 44,400 70,000

Average sale per invoice 450 314

% change from base year -30.23%

Sales Top 10 customers 6,000,000 4,300,000

% of net sales 30.00% 19.55%

Sales of Top 5 products 14,000,000 11,000,000

% of net sales 70.00% 50.00%

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Accounts receivable

ACCOUNTS RECEIVABLE

Net sales 20,000,000 22,000,000

Accounts receivable 3,300,000 5,500,000

% of net sales 16.50% 25.00%

Top 10 accounts receivable 900,000 1,100,000

% of accounts receivable 27.27% 20.00%

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Selling costs

SELLING COSTS

Gross sales 20,800,000 23,400,000

Sales returns and allowances -800,000 -1,400,000

% of gross sales 3.85% 5.98%

Net sales 20,000,000 22,000,000

Sales commissions 600,000 506,000

% of net sales 3.00% 2.30%

Advertising costs 1,100,000 1,700,000 Incl pay per click

% of net sales 5.50% 7.73%

All other selling costs 1,000,000 1,010,000

% of net sales 5.00% 4.59%

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Cost of sales

COST OF SALES

This year to date Annualized

Net sales 20,000,000 22,000,000

% of net sales 70.19% 71.21%

Purchases' costs 6,000,000 7,176,000

% of net sales 30.00% 32.62%

Payroll and benefits 2,538,000 3,045,000

% of net sales 12.69% 13.84%

Cost of sales other variable items 2,662,000 2,675,000

% of net sales 13.31% 12.16%

Cost of sales fixed items 2,912,000 2,970,240

% of net sales 14.56% 13.50%

Inventory - beginning 1,350,000 1,725,000

Inventory - end 1,425,000 1,925,000

Net change in inventory 75,000 200,000

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Cos t of s ales – usin g g ross sales and not ne t sales

COST OF SALES - Using gross sales

Gross sales 20,800,000 23,400,000

Purchases' costs 6,000,000 7,176,000

Payroll and benefits 2,538,000 3,045,000

Cost of sales other variable items 2,662,000 2,675,000

Cost of sales fixed items 2,912,000 2,970,240

Inventory - beginning 1,350,000 1,725,000

Inventory - end 1,425,000 1,925,000

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Sales invoices based on gross sales

SALES - based on gross sales

Gross sales 20,800,000 0 23,400,000

# invoices 44,400 70,000

Average sale per invoice 468 334

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Accounts payable

ACCOUNTS PAYABLE

Net sales 20,000,000 22,000,000

Accounts payable 1,250,000 1,700,000

% of net sales 6.25% 7.73%

Top 10 accounts payable 1,000,000 1,462,000

% of accounts payable 80.00% 86.00%

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Depreciation and F/A acquisitions

DEPR. AND FIXED ASSET ACQUIS.

Net sales 20,000,000 22,000,000

Depreciation incl in cost of sales 300,000 325,000

% of net sales 1.50% 1.48%

Fixed asset acquisitions 290,000 320,000

% of net sales 1.45% 1.45%

Excess of deprec over acquisitions 10,000 5,000

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Payroll costs

PAYROLL COSTS

Net sales 20,000,000 22,000,000

Payroll 1,800,000 2,100,000

Payroll taxes 234,000 273,000

Health care costs 396,000 546,000

Benefits 108,000 126,000

Total payroll costs 2,538,000 3,045,000

% of net sales 12.69% 13.84%

% of non payroll costs to payroll 41.00% 45.00%

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Sales’ c ompo nen ts

SALES' COMPONENTS

Gross sales 20,800,000 23,400,000

Sales Product A 7,280,000 8,892,000

Sales Product B 5,200,000 5,148,000

Sales Product C 3,328,000 3,744,000

Sales Product D 1,664,000 1,404,000

Sales Product E 624,000 702,000

Total sales of Products A to E 18,096,000 19,890,000

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Profit margin

PROFIT MARGIN

Net sales 20,000,000 22,000,000

Variable costs:

Purchases 6,000,000 7,176,000

Variable cost of sales items 2,662,000 2,675,000

Variable sales costs

Commissions 600,000 506,000

Sales expenses 100,000 101,000

Pay per click (incl in advertising) 55,000 385,000 Other variable costs

Insurance

Total variable costs 9,417,000 10,843,000

% of net sales 47.09% 49.29%

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Other items

OTHER ITEMS

Interest 180,000 180,000

% of net sales 0.90% 0.82%

Net income before taxes 788,000 204,160

% of net sales 3.94% 0.93%

Corporate tax payments 275,800 71,456

% of net sales 1.38% 0.32%

Net income 512,200 132,704

% of net sales 19.24% 4.96%

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3 things you will do because of this program

1.______________________________________________

________________________________________________

2.______________________________________________

________________________________________________

3.______________________________________________

________________________________________________

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Some suggested “3 things”

1. Look beyond the obvious numbers, especially the numbers the clients can generate themselves

2. Look for opportunities to create value every time you interact with your clients

3. Look to spot, uncover or identify trends

4. Use graphs and charts to illustrate your points

5. Advising clients on the big picture occasionally means

you need to look at the small numbers

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Conclusion

▪ We add value when we detect nascent trends and present our clients with credible information so they could make informed decisions and take

knowledgeable actions

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Thank you for attending

You are welcome to call Ed with your questions.

Ed can be reached at:

Ed Mendlowitz

WithumSmith+Brown, PC

1 Tower Center Boulevard, 14

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Peeling away the Layers of a Financial Statement to Provide Essential Advice