SBU Analysis: Drilling Into the Numbers

In my last blog on this subject (which I suggest you read before reading this blog), I described how the typical income statement masks the real causes of performance (both good and bad) for all but the simplest of companies.

In my last blog on this subject (which I suggest you read before reading this blog), I described how the typical income statement masks the real causes of performance (both good and bad) for all but the simplest of companies.

So, let's take a look at another company which has more than one group of customers and products/services. The example here is for a hypothetical swimming pool/spa firm (disclosure: I served on the board of such a company for several years, but the example does not portray the performance of that firm). 

The traditional income statement for this firm looks like this:

 

$

%

Sales

2,000,000

100.0

Cost of sales

1,400,000

70.0

Gross margin

600,000

30.0

As portrayed in the first blog, the cost of sales includes direct labor, materials and managerial expenses. The first takeaway is that this firm, in the year shown, has $600,000 to cover all other expenses (i.e., rent, insurance, utilities, etc.) and pre-tax profit. 

Unfortunately, this traditional income statement does not give a true picture of where the company is making money—or losing it—because it lacks the detailed examination of the profitability of customer groups and product/service groups.

This firm has three Strategic Business Units (SBU): Pool Design, Chemicals, and Repairs/Maintenance. The analysis of those three SBUs shows the following:

 

Design ($)

Design (%)

Chemicals ($)

Chemicals (%)

Repair/Maintenance ($)

Repair/Maintenance (%)

Sales

200,000

100.0

1,000,000

100.0

800,000

100.0

Cost of sales

140,000

70.0

680,000

68.0

580,000

72.5

Gross margin

60,000

30.0

320,000

32.0

220,000

27.5

Obviously, these three SBUs are not equal in size or performance. And that is typical when you employ an SBU analysis of performance. Without knowing anything about any given company's SBUs, I already know two things:

      1. Not all SBUs are created equal in size and/or performance.

      2. Not all SBUs have the same potential for growth and profitability.

So let's dig down some more. Each of these SBUs have distinct customer groups into which the firm sells. Let's take them one at a time.

Pool Design

Pool Design is a relatively specialized service few pool service companies offer, and this SBU represents a distinctive competence of this firm. From a cost standpoint, most expenses are for highly skilled engineering talent and CAD hardware and software. This portion of the business is highly cyclical—in a slow year, the full talents of an engineering staff are underutilized; in growth years, the full time engineering staff is hard pressed to handle the volume. Contract labor is adjusted up or down to keep the SBU in balance. Design frequently presents add-on opportunities to capture new Chemical and Repair/Maintenance customers. This SBU has two separate sets of customers: Municipal/Institutional customers and Hotel/Fitness Center customers.

Let's see what this SBU looks like when breaking it into two SBUs:

 

Municipal/Institutional ($)

Municipal/Institutional (%)

Hotel/Fitness Center ($)

Hotel/Fitness Center (%)

Sales

120,000

100.0

80,000

100.0

Cost of sales

84,000

70.0

56,000

70.0

Gross margin

36,000

30.0

24,000

30.0

This is one of those rare times where both SBUs have the same Gross Margin percentage. If viewed from a new customer acquisition process, these two SBUs are "keepers" as long as labor costs are kept under control.

Chemicals  

Pools and spas require regular testing and chemical products to maintain water quality. Chemicals are delivered via tank trucks (larger quantities) and in smaller containers that might be delivered with small vans or pickup trucks. In either case, but especially in the case of the tank trucks, drivers must have commercial licenses and all personnel need to have HAZMAT certification. This area of business serves three separate customer groups: Home, Municipal/Institutional, and Hotel/Fitness Centers.

Let's see what these SBUs look like:

 

Home ($)

Home (%)

Muni/Institutions ($)

Muni/Institutions (%)

Hotel/Fitness ($)

Hotel/Fitness (%)

Sales

500,000

100.0

300,000

100.0

200,000

100.0

Cost of sales

300,000

60.0

240,000

80.0

140,000

70.0

Gross margin

200,000

40.0

60,000

20.0

60,000

30.0

The Home customer SBU carries the highest margin as well as the highest sales. Deliveries can usually be made one or two times per month in season and often with less expensive driver labor. Municipalities and Institutions tend to be larger volume accounts that are serviced more often than the Home customers and usually by the higher cost tank trucks. Because of the gallonage requirements of these customers, other pool supply firms often bid at low margins to capture the volume business. It should be noted also that municipalities and sometimes institutions tend to pay slowly. The Hotel/Fitness segment presents many of the constraints in pricing and delivery found in the Municipal/Institutional market, but the margins could be higher because of other relationships (i.e., the firm's Design SBU might give a leg up on the competition). 

So, this level of analysis for the Chemical market present very different sales volumes and margins. If the owner has a choice, which of the three SBUs would he want to grow, given the above information?  If this level of analysis were not available to him, he would have to make strategic decisions with insufficient information about profitability and volume.

Repair/Maintenance

This segment of the business is a logical extension of services to Chemical customers as well as those who don't buy pool/spa chemicals from this firm. The major requirements in this SBU are for trained and experienced service technicians who have good trouble-shooting and problem-solving skills. Obviously, these technicians require a service vehicle and appropriate tools. They tend to be relatively highly paid, and the firm's ability to control labor costs and hold to established hourly billing rates is essential to success. The Repair/Maintenance segment services the same three customer groups as the Chemical segment.

Let's see what this segment looks like broken into three SBUs:

 

Home ($)

Home (%)

Muni/Institutional ($)

Muni/Institutional (%)

Hotel/Fitness ($)

Hotel/Fitness (%)

Sales

400,000

100.0

300,000

100.0

100,000

100.0

Cost of sales

280,000

70.0

240,000

80.0

60,000

60.0

Gross margin

120,000

30.0

60,000

20.0

40,000

40.0

As with the Chemical segment, the sales volumes and gross margins of these three SBUs are very different from each other. Again, absent this level of analysis, a decision maker would have a hard time determining which SBUs to grow and/or which SBUs to "fix" (such as the Municipal/Institutional SBU, which carries a very low gross margin).

Takeaways

Given the above, here are four things you can take away from what you just read:

1. Drilling down inside the business creates a very different picture of a complex (i.e., multi-SBU) enterprise than the traditional income statement provides.

2. Most businesses that are not organized to capture financial performance information by groupings of customers and products/services need to convert their financial information systems to capture the proper data. In my experience, this could easily be a major goal for the management team for at least two quarters if not more. It requires re-thinking about how the firm does business.

3. What is shown above could easily be drilled down even further. For example, are there major customers inside a given SBU that are unusually profitable or unusually unprofitable? 

4. Pareto, the Italian economist, came up with Pareto Analysis at least 500 years ago and states that 20% of a typical company's customers make up 80% of the firm's volume. That same 20% may or may not generate 80% of the firm's profitability. Doing a Pareto Analysis SBU-by-SBU frequently provides additional insights and might well be a strategic exercise worth doing.

Jeffrey C. Susbauer, Ph.D. is Associate Professor Emeritus at the Monte Ahuja College of Business, Cleveland State University where he has taught strategic management and entrepreneurship courses since 1970.  A long-time consultant to scores of businesses, a member of the boards of advisors to over 60 companies, he co-founded and serves as the principal instructor for the COSE Strategic Planning/CEO Development Course for the past 36 years. The course is concerned with providing entrepreneurs with education to guide their vision, strategic thinking and execution in their businesses.

Learn more about the Strategic Planning/CEO Development course or contact Jeff via email.

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  • Next up: Tax, Risk Management, Employee Benefit Strategies You Need to Know
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  • Tax, Risk Management, Employee Benefit Strategies You Need to Know

    During a recent workshop at the Greater Cleveland Partnership, the team from Apple Growth Partners spotlighted tips and questions business owners should keep in mind as it relates to tax planning, risk management and employee benefits.

    When was the last time you took a step back and examined whether your tax, risk management and employee benefit strategies accurately reflect the current (or even future) state of your business?

    If it’s been awhile—or even if you just need a quick refresher—check out these tips delivered by the team at Apple Growth Partners during a recent workshop the team presented at the Greater Cleveland Partnership’s offices.

    Business tax planning

    There’s been a lot of discussion lately surrounding the state of the tax landscape in the United States. Making sure your business is maximizing the value of its tax situation is critical.

    Here are six things to keep in mind when it comes to business tax planning.

    Tip No. 1: Ensure you are taking full advantage of the accelerated depreciation on fixed-asset purchases. Instead of expensing an acquired piece of machinery out over five years, it’s possible to expense it all in Year One.

    Tip No. 2: Look into research-and-development credits to unlock tax savings.

    Tip No. 3: Think about your future growth. Will you need to pull money out at some point? What about succession planning? Sit down and create a model of what you want your business to look like 10 years from now? And also 20 years from now.

    Tip No. 4: If you have purchased a building, did you do a cost segregation study? Just like with the machinery example in Tip No. 1, it’s possible to expense a portion of this purchase right away. This can create good cash flow for your company.

    Tip No. 5: Take a moment to review and evaluate what the impact of the new tax bill might be for your business.

    Tip No. 6: Think about the form of entity your business takes. If you’re a C-Corp, why? What happens if you sell your company? There’s a chance you might not want to be a C-Corp on exit because a potential buyer likely won’t be interested in buying the stock you have in your company. They’ll want your assets.

    Risk management

    The Apple Growth team also laid out three tips relating to the risk management side of your business.

    Tip No. 1: When you’re purchasing goods, have you considered adding specific terms and acknowledgments to the deal? This will allow you to put limitations on the terms you are accepting and offering.

    Tip No. 2: Make sure you understand the liabilities and penalties you could incur due to an accidental release of confidential information.

    Tip No. 3: Do you have a disaster contingency plan in place to ensure continuity of operations?

    Employee benefits

    Employees are the lifeblood of your business. And a strong employee benefits strategy will go a long way toward keeping your staff happy and productive. Here are six questions to keep in mind.

    Question No. 1: For qualified plans, are employee deferrals or loan payments being deposited in a timely manner?

    Question No. 2: Does the current design of your plan allow your business to maximize contributions? If not, you should consider making changes. Keep in mind many changes cannot be made after March.

    Question No. 3: Will you need to perform an audit at some point in the next two years?

    Question No. 4: Are fringe benefits being reported accurately?

    Question No. 5: Is employee data, such as Social Security numbers, accurately recorded?

    Question No. 6: Are employee achievement awards, such as gift cards, reported accurately. Those awards are considered taxable income.

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  • Next up: The Magic of SBU Analysis: The Traditional P&L Statement
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  • The Magic of SBU Analysis: The Traditional P&L Statement

    Does your Profit and Loss Statement look like this?

    Does your Profit and Loss Statement look like this?

     

    This year

    This year

    Last year

    Last year

     

    $

    %

    $

    %

    Sales revenue

    900,000

    100.0

    1,000,000

    100.0

    Cost of goods

    252,000

    28.0

    271,000

    27.1

    Cost of labor

    230,000

    26.0

    215,000

    21.5

    Overhead

    71,000

    8.0

    74,000

    7.4

    Cost of sales

    553,000

    61.0

    560,000

    56.0

    Gross margin

    347,000

    39.0

    440,000

    44.0

    SG&A*

    410,000

    46.0

    379,000

    37.9

    Pre tax profit

    (63,000)

    (7.0)

    61,000

    6.3

    Tax

    (12,600)

    (1.4)

    12,200

    1.2

    Profit after tax

    (50,400)

    (5.6)

    48,800

    4.9

    *If this statement were generated from your accounting system, the Selling, General and Administrative expenses (such as management salaries, rent, sales compensation, advertising/promotion, utilities, etc.) would be presented to you in detail.  For purposes of this article, detail of those items have been suppressed.

    What does the above P&L tell you?

    Sales have decreased while labor costs have increased as a percentage of sales from 21.5% to 26%. Cost of goods have moderately increased year to year. The SG&A expenses have exploded; a detailed look at the individual components of the SG&A will determine the culprits there. The company has experienced almost a $100,000 decrease in bottom line performance year to year.

    Some more analysis is in order. Why, for example, have the sales decreased while the cost of goods and cost of labor increased (both of the latter as a percentage of the sales)? Did new competition come into your market? Is your product not as competitive as it once was? Did you have to cut your price? Did you lose a customer(s)? Were there supplier price increases that were not passed along to customers? Did scrap/rework increase during the year? Did the staffing in production not get adjusted to the sales environment? Did employees get pay raises even though it was a down year? That does not even address the rapid rise in the SG&A portion of the P&L.

    IF this company is selling one product/service at the same price and cost to everyone through the same market channels and distribution logistics, this level of analysis gives a good overall snapshot of the venture's dynamics. The absence of profit—or very little profit—might even be acceptable if ownership is paying itself 8% to 10% of the revenue. This kind of firm is often referred to as a "lifestyle business".

    The Magic of the SBU

    The example above is what we call a "simple" business, or a "single Strategic Business Unit (SBU) business.” The single SBU business is one which has only one group of customers who buy in a similar manner products and/or services in a  fairly narrow price/cost range. An example of a simple, single SBU business might be a tax preparation service catering only to individual federal, state and local tax returns.

    In most cases, what is described above does not resemble fiscal reality and does not reflect how the business actually is constructed. Even if the products/services are sold at the same price to everyone, this level of analysis does not permit inspection of the real costs of the sale. If, for example, some sales are made via an Internet store, chances are that those sales carry lower overall selling and transaction costs than bricks and mortar sales do. It is also likely that deals are routinely struck to give price or terms breaks to larger transactions and/or key customers, and sales margins per unit are not all alike. 

    The SBU concept has been in place for several decades. General Electric under Jack Welsh, for example, treated each of its businesses as SBUs and evaluated performance and investment decisions by viewing each business as a group of SBUs within those businesses. If it worked for GE, might it not be worth considering in your business?

    Takeaways

    1. Accounting systems that lump all sales into one summary line miss the boat in helping to try to figure out how you make money and where you are making money. Similarly, that same bundling of labor and/or materials costs does the same disservice in your quest to determine the real costs and benefits of a given product/service. 

    2. Because most businesses aren't really simple (and that includes those which appear on the surface to be simple), SBU structure and analysis is the best way to account for differences and similarities in key components of the firm—especially groups of products/services offered to different groups of customers. 

    3. SBU structure helps to figure out the real areas where you make money. Different matches of products/services, priced incorrectly, for example, lead to underperformance of the firm.

    Because most businesses in reality are not simple single business businesses, the next article in this series will help explore different ways to help create SBU structure for making better, more informed decisions to improve performance and for establishing criteria for making decisions to move the company forward into the future. 

    Jeffrey C. Susbauer, Ph.D. is Associate Professor Emeritus at the Monte Ahuja College of Business, Cleveland State University where he has taught strategic management and entrepreneurship courses since 1970.  A long-time consultant to scores of businesses, a member of the boards of advisors to over 60 companies, he co-founded and serves as the principal instructor for the COSE Strategic Planning/CEO Development Course for the past 36 years. The course is concerned with providing entrepreneurs with education to guide their vision, strategic thinking and execution in their businesses.

    Want to learn more about the Strategic Planning/CEO Development course? Click here for additional information or contact Jeff via email.

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  • Next up: Protecting and Preserving Your Business for the Future: The Importance of Business Succession Planning
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  • Protecting and Preserving Your Business for the Future: The Importance of Business Succession Planning

    Building a successful business takes commitment, dedication, and a lot of hard work. And like anything of value, it must be protected – but not only against current risks such as fire or theft, but also against less tangible hazards such as the loss of an owner or key employee. Let’s face it, at some point in the life cycle of every successful business, one or more of three things will happen: an owner or key employee will die, become disabled, or simply decide to retire. Unfortunately, many business owners don’t take the time to plan for how their business will be run—or liquidated—following such an event. But without this kind of planning—generally known as business succession planning—even successful companies face the threat of failure. 

    Planning for the sale or transfer of a business or business interest should begin as soon as possible - while the business is successful and while the owners are healthy. In many cases, the foundation of effective succession planning is a buy-sell agreement, which should address:

    • How the buy/sell agreement will be funded. Will the money come from the owners themselves, or will the business fund the arrangement?
    • What kind of event will trigger the sale—death, disability, retirement? Maybe all three?
    • Who will actually buy the business interest—the remaining owners, a key employee or the business itself?

    A properly structured—and funded—buy/sell agreement can help answer these questions.

    What is a buy/sell agreement?
    A buy/sell agreement spells out the process by which a business or business interest are transferred following a “trigger” event—usually the death, disability, or retirement of one of the owners.

    Most buy/sell agreements take one of two forms—either they are “entity plans,” where the business agrees to purchase an owner’s interest in the business, or they are “cross-purchase plans,” where the business interest is purchased by the other owners. But while there are advantages and disadvantages to each type of plan, in many cases, neither arrangement fully meets the owners’ expectations or objectives. Tax issues, administration headaches, funding inequities, multiple insurance policies—just to name a few—can take much of the luster out of both types of buy/sell agreements. That’s where a Partnership Administration Success Strategy (PASS) can help. Under a PASS Plan, the benefits of both entity and cross-purchase plans can be made available, but without the drawbacks associated with either method.

    How can a PASS plan assist in buy/sell planning?
    The business owners enter into a cross-purchase buy-sell agreement, and the owners form a general partnership with all owners as general partners.  Each partner acquires a life insurance policy on himself and transfers it to the partnership as a capital contribution – the partnership becomes the owner and beneficiary of the policies. Policy premiums can be paid by the business by paying additional salary or bonus to the insured. The insured, in turn, transfers the cash to the partnership as a capital contribution, or the business itself may become a partner in the partnership and pay premiums directly to the partnership as a capital contribution.  The general partnership structure allows the partners the flexibility to allocate items of income, profit, gain and loss between themselves in a manner that meets their business objectives. This allows the partners to equalize cost and fairly distribute life insurance proceeds.

    Following the death of a partner, the life insurance proceeds from the policy covering that partner would flow into the partnership and be allocated to the surviving partners.The partnership would use a portion of the proceeds to purchase the deceased partner’s interest in the partnership. The balance of the proceeds would be distributed to the remaining partners. The remaining partners would then use those proceeds to purchase the deceased partner’s interest in the primary business.

    Using a general partnership to manage a buy/sell agreement can also be advantageous following the retirement or disability of an owner. In such a case, the partnership can distribute the disabled or retired owner’s life insurance policy to him or her in exchange for his or her interest in the partnership. The departing owner would assume ownership of his or her own policy income tax-fee. Over-funding of the life insurance policy(s)—a common strategy—would allow the remaining owners to access cash values in their policies as a resource to help them fulfill their obligation to purchase the departing owner’s interest in the business.

    Could a PASS plan be right for you?
    The benefits of using a buy/sell agreement to transfer a deceased, disabled, or retiring partner’s share of a business to the remaining owners are many. Unfortunately, the traditional methods don’t always work in the best interests of the business or business owner. Utilizing a general partnership to manage your buy/sell planning, however, could help mitigate the disadvantages presented by entity and cross purchase plans. The general partnership approach:

    • Requires only one life insurance policy per owner;
    • avoids the corporate Alternative Minimum Tax;
    • minimizes, through special allocations, inequities among partners in the cost of insurance coverage;
    • provides a full basis increase to the surviving partners after a partner’s death;
    • allows the surviving partners to distribute the insurance proceeds to themselves,
    • generally free of income taxes, in order to accomplish the business buy-out and;
    • permits the transfer of the policy insuring a departing partner to that partner income tax-free.

    As a planning vehicle, PASS combines the benefits of both entity and cross purchase plans – as well as additional benefits not present in either – while avoiding the disadvantages inherent in both. For all of these reasons, a Partnership Administration Success Strategy could be just what you, your partners, and your business needs to accomplish your goals and objectives.

    This content was prepared by The Penn Mutual Life Insurance Company and is intended to offer a general understanding of a Partnership Administration Success Strategy.  Any reference to the taxation of insurance products is based on Penn Mutual’s understanding of current tax laws; this information should not be construed as financial, legal or tax advice applicable to your situation.  Clients should consult a qualified advisor regarding their personal situation.

    Joseph Pilla is V.P. Advanced Strategies & Business Advisory Services for XXI 21st Century Financial 216-545-1781. Custom designed strategies for both individual & businesses through uses of; Business Valuations, Premium Financing, Business Succession/ Asset Protection/ Insurance/ Wealth Transfer/ Investment/ & Retirement Planning.

    © 2018 The Penn Mutual Life Insurance Company, Philadelphia, PA 19172

    2221548PH_Oct20

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  • Next up: Tips for Your Business: Keep the Cash Flowing
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  • Tips for Your Business: Keep the Cash Flowing

    Cash flow management is crucial in effectively managing your business finances. Having a positive cash flow shows lenders, investors and vendors that your business is in good financial health; a negative cash flow puts your business in serious financial risk. The difference between positive and negative cash flow can mean the difference between a successful year and bankruptcy.

    Cash flow management is crucial in effectively managing your business finances. Having a positive cash flow shows lenders, investors and vendors that your business is in good financial health; a negative cash flow puts your business in serious financial risk. The difference between positive and negative cash flow can mean the difference between a successful year and bankruptcy.

    Creating prolonged periods of positive cash flow goes much deeper than just reviewing your monthly bank statements. True cash flow management is a delicate balance, stemming from your ability to hold onto your cash for as long as possible while keeping a steady stream of money coming in. “What often happens is that a small business owner will focus too much on their checkbook balance and not on who owes them money or who they may owe,” says Rion Safier of Rion Safier Accounting. “It’s important to pay better attention to the whole process of billing, collecting and payments.”

    Most businesses at some point will experience negative cash flow, but that is not necessarily a sign of failure. Accounts receivables are almost always to blame – nearly 70 percent of businesses have accounts that are greater than 60 days past due. Other contributing factors include normal cyclicity or seasonality in business operations. If you can anticipate that someday down the road you may fall short on cash, arrange for a line of credit to cover operating expenses for when things get tight. If you wait until that day arrives, chances are you won’t get approved

    Want more expert advice? Check out COSE Expert Network, an online forum connecting business owners with creative solutions to the tough questions they face every day.

    This article originally appeared in the June 8, 2015, edition of Small Business Matters.

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  • Next up: Top SBA lenders in Northeast Ohio
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  • Top SBA lenders in Northeast Ohio

    Small business owners in Northeast Ohio have plenty of options when it comes to obtaining SBA loans. This list shows the top SBA lenders in the region during the past fiscal year.

    Small business owners in Northeast Ohio have plenty of options when it comes to obtaining SBA loans. This list shows the top SBA lenders in the region during the past fiscal year.

    This list of SBA 7a and SBA 504 Loan approvals is for the period Oct. 1, 2014 through Sept. 30, 2015.  Third  party lender loans associated with the SBA 504 projects are not included, and SBA 504 loans are associated with the corresponding Certified Development Company, not the participating bank. The cities shown on the list correspond with the bank headquarters, not the location of approvals. The approvals are for the geographic area of the 28 northern Ohio counties administered to by the Cleveland District Office of the U.S. Small Business Administration. These counties stretch across the northern third of the state, including Toledo, so this list is not solely northeast Ohio.

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