Income Statements and Budgets

Class NameInstructor NameDate, Semester

Foundations of Cost ControlDaniel Traster

Income Statements and Budgets

chapter 14

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.

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Three Financial Reports

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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)

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”

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Figure 14a: Portion of Common Size Income Statement

Total Sales $375,400 100.0%

Labor

Salaries and Wages $110,380 29.4%

Employee Benefits $24,838 6.6%

Total Labor Cost $135,218 36.0%

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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%

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Subcategories under “cost of sales” use different percent bases (not based on total sales)

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Food Cost

%Food Cost

Food Sales


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Beverage Cost

%

Beverage Cost

Beverage Sales


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Total Cost of

Goods Sold

Sum of Food and

Beverage Costs (variabl

e)


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Gross Profit

Money left from

sales after

total cost of goods sold is

deducted

Figure 14b: Portion of Common Size Income Statement

Sales Food $727,194 74.0% Beverage $255,561 26.0%Total Sales $982,755 100.0%Cost of Sales Food Cost $255,180 31.0% (% of food sales) Beverage Cost $58,804 23.0% (% of beverage

sales)Total Cost of Goods Sold

$283,984 28.9%

Gross Profit $698,771 71.1%

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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

Figure 14c: 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%

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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.)


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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


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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


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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

Figure 14d: 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%

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Occupancy Costs rent, property taxes, property insurance

Interest cost of using someone else’s money; like interest paid to a bank for a loan

Depreciationan accounting device used to spread a significant cost across multiple years based on the life expectancy of the purchased item (large equipment or renovations)

Fixed Costs includes 3 major categories:


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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

Figure 14e: 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%

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Income Statement Graphic Formula

• % column is calculated using the graphic below

• For food cost and beverage cost, “sales” is the corresponding food sales or beverage sales; all other items use “total sales” for sales.

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Cost

Sales x %

Example 14a

% = Cost ÷ Sales = $7,000 ÷ $380,000

= 1.8%

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On income statement, “marketing” is listed as $7,000. Total sales are $380,000. What percent should be written next to “marketing”?

Example 14b

Food Cost = Food Sales X % = $114,600 X 0.304

= $34,838

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Income statement lists food sales as $114,600. Manager wants to run a 30.4% food cost. What should food cost be in dollars?

Comparing Income Statements and 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

Income Statements Budgetsvs.

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.

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Figure 14f: Common Size Analysis

Budget 1/1/11-12/31/11

Budget Actual 1/1/11-12/31/11

Actual Variance

Sales Food $750,000 75.0% $727,194 74.0% (1.0) Beverage

$250,000 25.0% $255,561 26.0% 1.0

Total Sales

$1,000,000

100.0% $982,755 100.0% 0

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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

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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:

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%Dollar variance

Earlier time period (or budget) dollars

=

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

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Figure 14g: Comparative Analysis

Budget 1/1/11-12/31/11

Actual 1/1/11-12/31/11

Variance $ Variance %

Sales Food $750,000 $727,194 ($22,806) (3.0%) Beverage $250,000 $255,561 $5,561 2.2%Total Sales $1,000,000 $982,755 ($17,245) (1.7%)

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Why Comparative vs. Common Size Analysis?

• 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

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Comparative

Common Sizevs.

Creating a Budget

• Budget must be realistic to have any value• Goals of a budget:1. Predict revenue and expenses accurately2. 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

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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

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Prior to Writing a Budget

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Historical Data

• Usually comes from POS• Include:

―check average―customer counts―expense patterns and trends (in $ and %)―income statements over multiple years

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Historical Data is the starting point for the next budget.

Internal and External Variables

Internal come from outside the business.

• new equipment• menu changes

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Internal and External Variables are used to identify changes from prior trends.

External come from outside the business.

• new competitor• closure of local

business• spikes in food prices

External learned from trade publications, professional associations, news reports, customers and purveyors

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

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Example 14c

New amt = old amt. X (1 + % change) = $700,000 X (1 + 0.05)

= $735,000

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Total sales on income statement were $700,000. Management wants 5% increase in sales next year. What is next year’s total sales budget?

Example 14d

Cost = Sales X % = $735,000 X 0.049

= $36,015

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Management says “marketing” should be 4.9% of sales. If total sales are budgeted at $735,000, what is marketing budget?

Example 14e

New Cost = Old Cost X (1 + % change) = $17,300 X (1 + (-0.08))

= $17,300 X 0.92 = $15,916

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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?

Example 14f

Monthly = $4,800 + $800 + $630 = $6,230Annual = $6,230 X 12 months = $74,760

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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?

Planning for Profit

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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.

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 real-world

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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

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Dividing a Budget into Smaller Time Frames

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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.

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.

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3. Using next year’s annual sales forecast, calculate each month’s sales as: Annual Sales X % for a given month (from step 2)

%Monthly sales

Annual sales=

Example 14g

$33,300 ÷ $358,000 = 0.093 or 9.3% (August %)$380,000 X 0.093 = $35,340 (August sales)

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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?

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.

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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.

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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.

32nd week of the year)―For daily, compare the same day of the week of the prior

year (e.g. 2nd 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.

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Example 14h

• 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.

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If occupancy costs are divided evenly over the year, calculate the June expense

lines for cost of goods sold and for occupancy costs.

Example 14h (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

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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

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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.

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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

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Documents

Income Statements and Budgets