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An Income Statement That Makes Sense

Mar 10th 2010
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I previously wrote how income statement formats vary not just between industries but within industries.  I find this frustrating - why shouldn't say five different widget manufacturers that are essentially identical in their operations have identical income statement formats?  Or are five different ones superior to each other?  I know from experience that this drives potential acquirers positively batty - they have to recast things into a format that allows them to compare apples to apples.

Prior to starting my Firm, I was the CFO of a large southeast Michigan ready-mixed concrete producer.  I also was an active member of the Business Administration Committee of the National Ready Mixed Concrete Association.  The NRMCA produced (and still does I believe) an annual financial survey of concrete producers.  The format used was developed by Bill Allen of AllenVillere Partners.  I'm summarizing the detail, but it looks something like this:
Cost of sales:
            Variable product costs:
                                    Total variable costs
Gross margin
Fixed product costs:
Total cost of goods sold (sum of variable and fixed product costs)
Gross profit
Selling expenses
General and administrative expenses
Interest expense
Operating profit
Other income and expenses
Income before income taxes
Income taxes
Net income
It took me close to a year, but I converted our income statement to match this format. As we participated in the NRMCA financial survey, it allowed us to constantly benchmark our results against the industry leaders, the industry average, and against our region. Upper management would ask the head of operations questions like “Why are spending so much more per ton for cement then the region?” or “How come our tires cost so much less?”
Notice how it breaks out variable and fixed components of cost of sales. It essentially looks at what are the costs to deliver a cubic yard of concrete that you wouldn’t spend if you weren’t producing:
·         Materials – cement, stone, sand, water and other additives
·         Plant – wages and utilities to run the plant
·         Delivery – driver wages, fringes, fuel and tires
It also gives you gross margin. If you know your gross margin and your fixed costs, you know your break-even point. How many income statements tell you that?
I used to argue with Bill Allen about whether or not to include repairs and maintenance in variable costs; I was against it. We did most of our repairs and maintenance during the winter, when business was slow. As a result, we’d wind up with a negative gross margin during those months, which just didn’t make sense. On an annual basis though, it does make sense.
You may also notice that there were no material costs in the fixed cost section. That makes sense – you only needed to buy materials if you were producing concrete.
By now, you might be thinking this is all well and good, but I’m not in the concrete business. But if you are in some kind of manufacturing business, this model, with some modifications, will work. As I’ve mentioned previously, I work with several restaurant groups. They have variable material costs – food and beverage. They have variable plant costs – the kitchen. And they have variable delivery costs – servers. 
Give it some thought and let me know what you think.