Expense control is a critical part of managing profits.
Every business must focus continually on managing profit and loss to remain solvent. Profit is the money a company keeps after paying all of its expenses. A loss results from expenses exceeding the amount of sales a company makes in a specific accounting period. Companies must manage their income statements, also known as profit and loss statements, to keep earnings positive and expenses under control and in line with revenue.
Initial Financial Assessment
Managing profit and loss begins with an assessment of the company's current financial position. Management must review the current profit and loss statement and compare it to the company's last two or three years of historical data. An accountant or analyst can use this information to establish a set of performance benchmarks for the company's average revenue and expense levels.
Preparing Analytical Tools
Management should have an accountant or analyst prepare analytical tools such as a common-size income statement. This income statement shows every expense as a percentage of sales, allowing management to isolate costs that could contribute to decreasing profits. The company can perform this analysis for, preferably, three years of historical data. An analyst compares the three years to each other by reading across horizontally. Expenses as a percent of revenue are compared for each year to reveal trends that show expenses rising or lowering as a percent of sales over time. Some costs, such as the cost of goods sold, will naturally rise with sales increases because they represent the raw goods used to make products to sell. Building rent, administrative costs and some utility bills should remain the same, regardless of increases in sales.
Explaining Expense Growth
An analyst should perform additional work to investigate and explain expenses that show growth over time as a percent of sales. This exercise can reveal valuable information about the company's use of resources and managerial cost oversight. External factors such as the economy and rising prices also can explain cost increases.
Sales Review
An analyst should next review the company's sales. Depending on various events and conditions, even when internal expenses have been well-managed and cut as low as possible, the company may still suffer a loss if its sales drop below its expenses in any given accounting period. In this case, the company must make important decisions such as discontinuing certain unprofitable product or service lines, selling off assets to free up capital and discontinuing investments in any projects that do not generate revenue.
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