The P&L is undoubtedly one of the core documents and metrics of any business. Indeed no matter what sort of business you are in you are required to generate some form of it at least once per year. However the P&L has a number of what can best be described as “blind spots” which a business leader is wise to shine a light on using other forms of metric (reported no less rigorously than the P&L).
The main areas of “blindness” of the P&L in my mind are:-
- Narrow Horizons
- A scorecard not a match report
- Needs de-consolidation to be useful
- Not engaging
- What about the cash
In the first of this series of blogs I am going to look at the narrow horizons of the P&L.
The main body of most P&Ls are focused on the period between first specific spend on fulfilling an order and sending out the invoice (buying or issuing material to shipping and/or invoicing for a manufacturing business). Other functions such as selling, warranty, NPI etc are usually lumped in overheads and seldom get enough detailed attention. Part of the reason for this is the accounting principle of “matching” which requires that costs and revenues be matched up so that materials used in the manufacture of a product are taken to the P&L in the same period as the sale is invoiced. Many business take great pains to match costs and revenues in the operating accounts, but doing this with overheads such as sale and warranty expenses is very difficult and seldom achieved. Thus the high salepersons costs this month is unlikely to be reflected in this months sales, or maybe not even this months orders.
The P&L is virtually silent on the whole area of issuing quotations and booking orders, although the quantity, value and margin of those quotations and orders are critical to the future of the business. This is particularly true where businesses have a long time between when they issue a quotation and finally deliver the goods. What metrics are appropriate for the quotations and orders area depends on the business, however some worth considering are:-
- Value (almost always appropriate)
- Margin (this metric is open to interpretation and needs care because small changes to sale contract can have large impacts on margin)
- Conversion rate
- Quotations & Orders from existing customers
- Quotations & Order from new customers
- Number of re-quotes
- Change of margin and value from first quotation to acceptance
- Quotation progress (eg. when tendering how often does the business to each stage).
What is almost always true is that issues identified early (at the quotation stage) tend to be more easilly and cheaply resolved thus maximising margin
A similar situation occurs at the other end of the business cycle. The P&L will capture warranty and post supply costs, but cannot link them to a cause or time when the issues originated. Possible metrics in this area are mainly centered around identifying root causes.
A small business with long business cycles was doing quite well but margins were drifting down. The business had metrics for value of quotations and orders outstanding but little else. A study was undertaken and it was identified that in order to win business the sales team were cutting margins. In fact despite the business targeting a gross margin in the 30% range it was actually sending quotations in the 20% range. Installing a board level metric on quoted margin allowed the management to focus on it and work out a solution.
A capital equipment business was meeting it’s sales budget but again margin was slipping – it had a M£2 per annum hole in P&L which they could not get a handle on although the suspicion existed that it was a quality issue. Some diagnostic metrics identified the cause after a few weeks – the business was accepting major contracts with ambiguous terms. Whilst the goods left the business on target margin, haggling over what compliance to contract meant with the client resulted in giveaways to encourage the client to settle the account. The accounts department following “matching” added all these costs to the appropriate jobs in retrospect. You can imagine the confusion of the manufacturing staff who see goods leave the factory hitting build cost target, and then the build cost climbing up and up over the subsequent accounting periods when the goods were not even in the factory. The fix in this case was a mixture of tightening contractual review, and measuring the post shipment supply of resources to customers.
Thus non P&L metrics and KPI’s can be useful in identifying quite well established issues within the business, to look at other short coming of the P&L and benefits of well targeted metrics read the next blog in this series.