A recent experience showed once again the value of careful analysis of financial information.
Two owners of a local deli restaurant had experienced some great results with their first
attempt at being entrepreneurs. Their sandwich shop took off immediately, due to the fact that “our sandwiches are not just a pile of lettuce with a little meat on the top”. In fact the sandwiches were created with a full four ounces of high quality meat.
The first year profits were impressive, so another location was selected and opened. This second restaurant took some time to get up and going, but eventually the sales of the second location were almost equal to the first. While profits did not double, they did increase and all was going well. And, importantly, the owners did not have to be there doing everything every day.
The second full year of two stores however showed a significant decrease in profit from the first year and we were called in to help determine why. The prior accountant’s answer was always “they’re your numbers” and “you have added too much overhead”.
An initial analysis of comparative financial statements revealed a bit more overhead, a slight increase in sales but a much larger increase in costs, particularly of beef. Immediately management went to invoices to see why meat prices were increasing so dramatically. Plans were made to confront the vendors who “were gauging us on their meat prices”.
A search on the Internet revealed that there had been significant overall increases in the price of beef, but not nearly enough to explain the cost increases with these restaurants. “We’ve got to raise the prices of our sandwiches to cover our increased costs!” was the response from management.
There was also concern that perhaps meat was going out the back door with employees since the owners were not always at the store. A proposal to install security cameras was made and an assignment to investigate their cost was given.
So the decisions were hastily made to look for new vendors and beat them down on price, raise the price of sandwiches and install security cameras because you can’t trust the employees. All somewhat negative and defensive responses to the situation.
We asked questions, some of them “dumb ones”, and most were swept aside without much consideration. Management was upset, the causes of the lost profits were obvious, and the solutions to fix the problem were finalized.
We persisted, however, and asked about portion sizes, considering that perhaps too much meat was being put on the sandwiches. “That can’t be the problem, our employees are well trained” was the somewhat angry reply. “Plus the way we prepare our sandwiches it would take way too much time to sit and weigh the meat on every one!” Nonetheless we were successful in convincing management to track meat usage for just one day.
The results? The four ounce sandwiches contained, on average 4.6 ounces of meat! That six tenths of an ounce meant that the cost of meat was 15% higher than it should have been. However, the biggest impact was not the higher cost of meat, but the lost revenue from not having that meat available to sell! So while 100 pounds of meat should have yielded revenue from 400 sandwiches, they were only actually selling 350. The same quantity of meat was producing 12.5% less revenue that it should have, and this was all falling to (and off of!) the bottom line.
As business consultants to our clients our job it to thoroughly investigate the actions that the numbers in the financial statements summarize. As suggested by Patrick Lencioni in Getting Naked we need to overcome the “fear of being embarrassed and ask dumb questions”. As we do so we will often get past the obvious but sometimes incorrect answers and discover the real reasons for the results our clients are getting.
Jeff Dredge, CPA, is a partner in the firm Morris - Dredge.