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We have seen all the main issues regarding the high section of the P&L statement. We have learned that each and every line should be analyzed according to responsibility criteria. We have also seen how measures should mimic the sales events.
Now it's time to go below the net sales value and see what to do with costs.

There are some different approaches on how to structure costs in a P&L and, once again, they depend on the company business model. The implementer is given a list of measures in a specific sequence, but what's the rationale behind that? Usually the cost structure follows two guidelines: identify some levers the management can pull and spot external events which are not under management control but influence the margins.
We'll be discussing costs for many posts, because a large part of the managerial accounting doctrine is about cost control. Rather than doing a long theoretical introduction, we'll see some commonly used costing models.

The easiest costing schema is listing direct costs first and indirect costs down the row. Direct costs are those which can be directly traced to a product. The cost of raw materials used to manufacture an item, the cost of the people who manufactured it is a direct cost. These are usually very easy to calculate. If they're not given, a simple division will get the result. The cost engine of many ERPs does the job easily. Indirect costs are all those costs that can't be traced directly to the single product. For example, the plant director's salary can't be traced directly to a product. To associate them to a product, a process called "Allocation" must be applied; we'll talk about that in later post.

Actually a cost can be defined as direct if it can be traced to a "cost object", that might be a product, a unit of service or even an employee. The same plant director's salary becomes a direct cost if we refer to the employee.
So, why are we talking direct costs to product? Because the product usually defines the lowest detail level in the orders or invoices which aggregate into the P&L. As said before, the ultimate purpose of a P&L is to evaluate a customer's or a product's or whatever's profitability. Attach a cost to the product and you'll attach a cost to every invoice row. It will easily roll-up into aggregated costs.
Note that the role of the product may be taken by whatever takes its role at the lowest sale level. It may be a working hour for a specific professional figure, a 30 seconds clip on the local radio and so on. You should always have somewhere in the company systems a table that says "sold n items of the x thing", and x is the object to refer the costs to.

What are the most widely used direct costs? As usual, it depends on the business model, but let's try to do a list with the usual manufacturing company in mind (we'll have different examples in the future).

Commissions: they're often calculated as a percentage of the sale, so it's easy to associate it with the product. There are more complex environments but, ultimately, they're linked to "what" is sold, that is, the product.

Cost of goods sold: these are the costs related to manufacture (or buy) what is (re)sold. They are usually split into: Materials: raw or semi-finished purchased to manufacture the product. Given the product components, these can be precisely defined. Usually they're calculated by the ERP cost engine. Machines: the cost of running the machines for a single product item. These are harder to calculate but they're usually pretty linear with the production. A limited cost accounting process may be necessary to define them but often few divisions are enough. Manpower: these are the salaries of the people who are directly involved in manufacturing the product. Given the time spent to produce a single item, those costs are easily calculated from salaries.

Freight: it's a direct cost because it refers to a specific transport, but it may be difficult to calculate because of the freighter pricing. Usually, some simplifications offer a good approximation.

These costs are often used because they're the easiest to be calculated, and they're already somewhere in an accessible format. These are also the old school costs because they relate to levers easy to pull.
Is the workforce cost too high? Let's pay less those dawdlers or make them work faster!
Are components costs too high? Let's grab suppliers' ties and pull!
Are machines too expensive? Let's keep working with the old steamers!
I could go on but I imagine that the concept is clear.

See you next time!

At the top of P&L tower sales. This is the starting point for each and every analysis. Then you subtract the costs and get the margin, right? Wrong. What about the other sales events?
Better, what is a sales event? There are four main sales events, the orders, the returns , the complimentary offers and the giveaways.

The orders, or better, all the documents that start from quotations to invoices are the main event, these provide the actual revenues and are quite commonplace. I'm sure you already know many ways to implement them in a datamart. I'm not going to teach you how to work with them.

Returns are technically related to orders or invoices, as they're often implemented like an invoice or shipment with negative quantities and values. They're also a cost because there's no profit associated with them and money will likely be returned to the purchaser. Processing returns is also an extra cost, unforeseen at the beginning. What's the correct value for returns? What does managers expect on that figure?
The simplest way to calculate returns value is just getting the associated document values. It is a direct subtraction from revenues, so it perfectly makes sense. A more sophisticated approach might include the related returns handling and freight costs, if they can be identified. They're direct costs but, if lumped together with the equivalent costs for orders (we will meet them in a coming post), may cause indicators and averages to drift.
A totally different game is about, which returns should be included in the P&L and which shouldn't. A return caused by product defects should not weight on the sales manager shoulders. A return caused by a mistaken shipment should be accounted to whom made the mistake. The P&L for the general manager should include all the returns. As you can easily imagine the same responsibility principle seen in previous posts apply here. Depending on who consumes the data, the model must be different.

Complimentary offers are indeed a sales event, usually they produce orders whose lines are zeroed or the sum is discounted by 100%. They must be subtracted because they're a cost directly applied to the customer which is presented with something free. The point is: what value should I place there? If you have, somewhere on the originating document, the price value of the free item, the temptation to use it is irresistible. Unluckily, it's almost always wrong. These are not lost sales to be subtracted from the total amount, these are costs (or investments?) incurred to "please" the customer, help it selling your stuff better or any other promotional purpose. Likely, there was no chance to sell these items in the first place, they are not "fake" sales. So the right way to give a value to complimentary offers is at cost. That is, the cost of having those orders through the door must be compensated by actual sales.

Giveaways may look like the same as above, but they're not. They're something that you give away because the customer already purchased something else. While they still can be considered as a sort of investment to keep the customer happy, they are sales intentionally missed. That's why they can be set at price value.

This schema is not universal and depends heavily on the specific market. The key concepts of responsibility, cost and price valuations, freebies to make sales and freebies because of sales made, though, can be applied in every market.

There are some other minor events that should be taken in consideration: financial credit notes and, very rare, other financial documents. These two occur when there's a money exchange not related directly with an exchange of goods and services. They cover various events and, sometimes, their amount is proportionally high enough to be taken into consideration in the P&L. Like for returns, the reason why the note has been issued guides the model implementation.

This is it for now. See you at the next post of the Business Analysis storyline.

photo courtesy wadem

This is a leap forward along the Business Analysis storyline, but I recently wrote about it elsewhere and I realized that this simple model can be of great help for startups. I'm going to talk about your company balances, but not in the terms you're thinking.

Have you ever thought about what can kill your business? I'm sure you did many times. Actually there are 3 easy concepts that can help you assuring the long term wealth of your company. These are 3, rather simple, checks you can do to verify the chances your business have to grow and prosper.

A business is financially balanced (in financial equilibrium) if it can pay all the bills when they are due. You should be able to pay for whatever you need to keep the company up and running (including debt) with your ordinary activities revenues. Any imbalance means that money must be harvested, from banks, investors etc, to keep the company running. Protracted imbalances may lead to a cash crisis that can actually kill the company. To be sure not to incur into financial imbalances, you have to forecast and constantly update your cash flow statement for the months to come. How to build a cash flow is beyond the scope of this article but we'll see it in the future.

A business is economically balanced (economic equilibrium) if there's a margin after every cost has been accounted for. This is not the same as before because you buy raw materials today, use them after one month, sell after two and cash in after three; this is often referred as the monetary cycle. All these activities, albeit distributed in time, are all related to a single unit of activity. In other words, disregarding the actual payments, we can make an estimate if every company activity is profitable or not, if it produces a positive margin or not. Your company as a whole, for each month of activity, must produce a positive margin. If your margin is red, cash flowing in from previous periods can temporarily compensate, but you risk to fall back on the case above.

Note that you can have a continuous row of positive margins but hit a cash crisis, because an unforeseen expense has lowered your cash or an important customer has delayed its payments. You can do everything well and still have cash problems. This is why the financial balance is more important than the economic balance and must be carefully safeguarded.

The third and final balance is the equity balance. A company has been founded upon an amount of money. In the medium/long term, the company must repay this equity in terms of dividends. The overall interest rate on the equity should also be higher than other investments to remain a viable option for the investors. This measures if the company can be profitable in the medium/long term. If every income cent is invested back in the company to make it grow or for R&D, nothing is left to pay the investors which, in turn, invested in a view to gain money. For a small, family owned, company, keeping it running is enough to make a living but, for larger companies, this may be a crucial, long term parameter.

So, when reviewing figures, start thinking in terms of the three balances, and let me know if you discover something new.

Take care

I'm sure that you often had to do with sales data marts. I'm sure you designed, implemented and reported against it many times. Actually, sales and margins are often the first business areas to be covered by a BI implementation. Sometimes accounting leads the pack, but usually sales are the first subject on the list.
Implementing sales is somewhat easier than other datamarts because the granularity is almost invariably defined by the sales events. That is, each line in your fact table will likely be an order/invoice line.

Defining what dimensions to add is rather simple. We'll have customers, products or activities, sales force and many dates; plus a bunch of minor or degenerated dimensions.
Conversely, defining dimension structures is not trivial at all as their layout greatly vary with the specific business. A shop order company works differently than a consumer packaged goods company, which, in turn, is different from a consulting shop or a resort business. There's no point in describing all the possible attributes for every business, but there are few criteria which should always be met because your business users will likely need them.

The company will have various level of commercial responsibilities: there are going to be product managers who take care of a product line and area managers who deal with a group of customers or channel managers who deal with a sales channel etc. Sales must be sliceable according to this group of responsibilities to adhere to the business vision the company has adopted. Each level of responsibility must be provided with its own data.
This is not as easy as it may seem. First, not all the aggregation levels required are necessarily defined into source systems. While each customer is assigned to a salesman, maybe a dummy one, areas may not be defined as well. Sales force may be an unbalanced hierarchy, thus adding a further complexity level. This is when external, manual, data must be added to the datawarehouse.

In some cases, some very complex responsibility schemas are implemented. A single position might control sales of a product group for an area, but all the products for some customers. That is, data might have to be sliced through different dimensions to comply to sales responsibility. Often BI clients can accommodate this, but defining an appropriate, mixed, dimension can also be of help, especially in defining specific KPIs.

I'm not done with the highest rows of the P&L, there's another topic about sales structure: how to organize the sales events. But I save this for the next post.

This is the fourth post dedicated to business analysis for BI consultants. The series start here.

In the previous post we saw that the Income Statement may have multiple forms (and even multiple names, because it is sometimes called Profit & Loss statement, P&L). An Income statement suited for management purposes shows costs related to the company operations, usually splitting them among direct and indirect costs. So far, we have designed a companywide Income Statement while management often needs data at a lower level. So you'll be asked to build a sliceable income statement. I'm sure many are familiar with the idea; from a technical perspective is "just another dimension", but what are the business perspectives tied to those dimensions?

Considering the company as a whole, two kind of dimensions come into play: business line and business unit. The business line mirrors a specific internal organization upon different business. Consider a company which manufactures bulldozers. It runs two entirely different businesses: the dozers business (with salesmen, expositions, advertising, large customers and small owners etc.) and the spare parts business (with country repairers, inventory turns, urgent calls etc.). No use to say, these are very different organizations with different people with different operations and mindset. Nonetheless, the two lines use some common services, like accounting, human resources etc.

The business unit is the radicalization of this concept or the result of an aggregation of more than one company. Business units are practically companies of their own. In fact, a business unit is often defined such by having its own P&L statement whose format can be different from other business units. What's important to understand, in our perspective, is that two business lines or two business units may greatly differ for the others dimensions. Just think to the bulldozers example, they indeed have a different sales force and an entire machine is likely classified rather differently than a spare part.

There's a third concept that many "Db Wizards" do not even suspect it's there. We talk about business and sales, hearth movers sales, spare parts sales an old machinery sold as second-hand toolsets. What distinguish the first two items from the latter? They are all sales, aren't they? Yes, they're sales but getting rid of old machinery is not part of the company everyday operations. A managerial P&L tracks only the ordinary activity, the company income statement tracks everything. One of the requisites for the company to thrive is to have a positive bottom line for the ordinary activity.

So far we haven't reached even the first line of the P&L statement, usually sales. In the next post we'll discuss how to slice and dice sales.

Here you can find a nice example of P&L statement for a software company, Qlik Tech, which is going IPO.

http://www.kellblog.com/wp-content/uploads/2010/04/qliktech-financials4.png

What's interesting here is the revenue vs costs breakdown. Each revenue item is a business line and each business line shows its own costs. These are not properly business units because there are a lot of common costs in the lower segment. The inner structure of those costs deal are poeple costs, but their internal breakdown may be a lot different.  

This pic comes from Dave Kellog's blog which draws an excellent picture of Qlik market and financial position.

Let's get a short break from blogging to list a few books I've found useful. If you want to run ahead of the lessons, well, use these texts!

This is a good, hands-on, primer for understanding the basics of business analysis.

This is quite costly but has formed generations of students. A must read.

Probably you think that accounting is a boring and dry subject, don't you?

I'll be back soon with the next post. Good reading!!

In the previous post we saw the classic, but I'd rather say the "accountant's" form of the Income Statement. Income Statements do not come always in this forms, there are many other forms, each one focuses on different company facts.

For example, in a manufacturing company it might look like this:

A manufacturing company focuses on issues like the manufacturing costs or the finished goods warehouse (it has impact on taxation and crystallizes money into something that sits on a shelf, but this is an entirely different matter).
Once more, this form gives an informative view on the company as a whole but does not tell a lot about what a manager can directly influence, that is, the operations.

Actually one of the first things that often go implemented in a BI project is a data-mart that gives you back something like this.

This statement appears to mix various things but, at a closer look, you'll find some interesting points.

First, costs are split between direct, that is costs which can be associated directly to the product sold and Indirect, which can't. This method is named "Direct Costing", we'll learn more later about that.

Second, note that each row is closely related to a specific function. In J&B computers there's someone who's in charge for selling HW, someone who sells consulting services, someone who checks that travel expenses do not balloon unexpectedly and so on.
This point is very important, the managerial income statement is split according to a principle of accountability. There should be someone who's in charge of the figures in a row. It's not the only principle, but the most relevant to understand why a specific cost structure is chosen.

Third, it ends with Margin and not with Income. Margin is what remains after all the costs and expenditures have gone into effect to produce the sales. Is it the same as the Income? Absolutely not, they're "cousins" but they are calculated in different ways. The margin tells you that the major ongoing operations produced more money than the amount burnt to produce the sales.
If you have a global negative margin, sooner or later you'll have to borrow money. If the margin keeps being negative, you're toast.

Be aware that the rows may vary, depending on what you need to keep an eye on. A manufacturing company will likely have a detailed production cost breakdown, even with some cost allocations. Others, which heavily use coupons and special prices may have those as a cost. Designing a managerial income statement suited to the company is one of the tasks those management consultants paid twice than you are appointed to do but that can be done just asking the right questions to management .

So now you see a report, and I know many among you already know how to implement it by their favorite BI tool. Before closing the post I just want to point out that this report sucks. It sucks because no number has a meaning if it is not compared to another number. It may be the budget or the previous year same period, but your report need to look like this.

Here 2009 and 2008 are side by side. For each year, each row shows the percentage respect to Total Sales. We already said that this is a scalar report, so a manager reads it to learn how many point are "eroded" by a particular row. This makes comparison non dimensional thus showing efficiency gains or losses. The comparison between the two years is made on the percentage points gained or lost.
For example the warehouse and logistics which handle the HW have slightly lost efficiency, having lost .2 point in 2009.
Administrative expenses have been well polished, because they are down a point out of 5 and a half in 2009.
If you have to choose an area to work on to improve margins, just work in obtaining better discounts from HW vendors because HW purchases make 40 points alone and they're up 3 point from 2008. This is the kind of analysis a manager does.
Now watch consulting labor, it is down 2.61 points, which sounds good, but consulting is down by 5.6 points, so you actually lost 3 points of efficiency! All of this, while total consulting value grew!
Anyway, everything summed up, your margin is up 3.53 points and the world is beautiful.

I hope I have given an idea of what managers do with your income statement. In the next post we'll see how to implement it and how to add dimensions to the analysis.

Stay tuned and, please, tweet this post for your friends and coworkers

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One of the most common user request is "How much am I earning?" This question is second only to "How much am I selling?". Often projects start just to have an efficient reply to these two questions.
Notice that the two questions are only superficially similar but an ocean lays in the middle . Let's start.

I'm sure you've been asked many times to create sales reports. They're important, but they describe only a fraction of reality. A company general manager is much more interested in different figures, that is the money left after paying what must be paid and collecting the credit.
As you probably know, the broad definition of this figure is:

Sales - Cost = Income

Reports usually do not have one row (albeit some widgets from famous BI players provide what's exactly one row of data), but are drawn in the form of the income statement. A traditional income statement, for a commercial company, may look like this:

Probably you've already seen this or something similar around or in a book. This is the classical income statement that the company CFO prepares at the end of the year. For example, find here the Microsoft Income Statement. You will likely not be asked to create this because the accounting systems already produces it and it is carefully adjusted by hand on Excel before being validated by the board. For a "no frills" detailed description you can go here.

Before moving on, nonetheless, there are two key aspects I want you to notice.

This is a scalar report, that is, starts from a value, subtracts other values, has intermediate totals and ends with a much lower value. The business meaning of this is that the Revenues are "consumed" by costs and expenses and what's left is the "money" (it is not exactly true but I skip by now) available to be pocketed or reinvested.

This statement refers to a whole year, that is, summarizes Facts which took place in 2009 or, somehow, pertain to 2009. The word "pertain", hides the accounting accrual concept. I've read very long chapters about it but the point you need to get is very simple: costs pertain to the period when the associate resource has been consumed.
Simpler: the cost of goods sold is accounted in the same period as the sale.

An income statement like this depicts company business in little detail. It's ok, more or less, for Wall Street financial analysts and it says that, yes, somehow, in 2009 you should end up with more money than in 2008; but does not tell so much about how actually running the business. In the next chapter we'll see what a chameleon the Income Statement is.

Stay tuned and, please, tweet this post for your friends and coworkers

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If you want to try version 1.1 go here

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We've been talking too much about technologies, myself included.

There's a focus in BI community on the emerging trends of cloud computing, in memory processing, columnar stores etc. but the link with business requirements is weak.

In my experience of a life spent in small and midsize BI projects I've never found a business manager or an entrepreneur really caring about the technicalities of a solution. They see it as a black box where to pour an amount of money in to get back some capabilities, possibly to be translated into ROI.
The general mood is "do what you need with that box, I need the result". Usually it is hard to explain to a business user why she can't see the data formatted like he wants, if all those data are available; the usual reaction is "why you can't do something to get it?".

So, during the years, I've found myself developing a business management culture and getting more and more business analysis skills. Today, with few exceptions, my project documents are always business talks, focusing on business issues and describing systems to cope with it or to keep an eye on. The technical part is for the CIO who is often happy to let the consultant do all the dirty job of defining requirements and targets.
Someone says that the eye candy of modern platforms can make the difference and win a contract; I despise this approach, it's for the professional liar. I prefer showing the business people that I actually understand them and I can cater actual solutions. I seldom give demos, I prefer to sit and listen. I seldom write 300 pages of specs, I write 10 pages of business analysis and they're usually enough.

I do not have the experience of some of the people hanging around my blog, but I found this approach to be highly effective.
So I think that I should help BI consultants to better understand their customers. Understanding your customers let you build a better link between the tech requirement and the business requirement, let you serve them better and let you ask for higher fares.
Do not underestimate the amount of business knowledge required to set up a coherent management control system; for you, as a technician, some aspects are just reduced to "one more field" or "one more table", but they have deep business implications.

This is the introductory post of a series dedicated to business analysis for BI consultants.

The most correct choice is to describe the business environment in the academic order, like a university course in business analysis. Being practical, I'm going to start covering the topics in an order in which they are implemented or are important to know.

I assume that the reader has already an average knowledge of relational and olap databases and is familiar with the BI terminology and with the basic datawarehouse concepts.

The work is not completely unbiased and it will reflect my personal career. Examples will cover many economy sectors but not banking, insurance and investments in general because I have only a marginal experience on those. A different type of bias also comes from my experience on the Italian market, albeit often with internationalized companies.

Let me know if there's a topic you'd like to see covered.

I hope you'll enjoy the posts so I can keep doing the very clever professor who puffs his pipe and sneaks Viney@rd in!

In the next post, we'll start with what companies live and die for, income.

See you soon and, please, tweet this post for your friends and coworkers

If you want to be a part of the Viney@rd 1.2 private beta program visit http://www.straysoft.com/beta12.html

If you want to try version 1.1 go here

If you want to learn something more about Viney@rd, please visit http://www.straysoft.com.