Operations: Functional Accounting, Part 3
Functional accounting prepares you to be able to function in the business side of our industry. Everyone should understand what was covered in our first two articles: the Accounting Process and the basic Financial Statements. Now, we will go over the “Key Ratios” and formulas that are part of our businesses on a day-to-day basis, and by understanding and using them, you will become a stronger operator. Managing and watching your revenues and expenses is crucial at all times. Never let your guard down.
Inventory management is a major part of most multipurpose club operations. Working under the accrual method of accounting, purchases of inventory items (food items, retail items, etc.) is a Balance Sheet transaction and only moves to the Income Statement when the items are used (gone).
Remember, under accrual accounting, revenues and expenses are recognized when they are incurred, not necessarily when the cash is received or spent. To calculate this, inventories are created and are counted on a regular basis (usually monthly or quarterly). Inventory items are counted at the lesser of retail or cost values. What moves to the Income Statement is the value of the items which are gone during that period — the Cost of Goods Sold (COGS). To calculate this, use the following formula:
- Beginning Inventory $__________(This is your ending inventory from the previous month)
- +Purchases $__________
- -Ending Inventory $__________(This becomes your beginning inventory for next month)
- = COGS
Using this formula, assume that you started with an inventory with $10,000 of items in it. You then purchased $5,000 worth of items during the month. When you counted the inventory at the end of the month, it had $6,000 worth of items left. Using this formula, your COGS — which would be put on the Income Statement because these items are now gone and the costs are incurred — is $9,000 ($10,000 + $5,000 – $6,000).
A lot of people get mixed up here because they say they purchased $5,000, why is it $9,000 and not $5,000? Remember, under the accrual method, it is not about what is spent, but what is incurred, in this case used in the sale of the items. So, $9,000 worth of product is now gone, and that is what your expense is. The $6,000 left stays on the balance sheet as an asset. It has true value until you use it just like cash, so it belongs as an asset on the Balance Sheet.
A lot of dollars are invested in inventories, so managing the level of the inventory is crucial to make sure you don’t tie up cash too long because items take forever to sell or just because you have too many items. Having too many will also weaken your ability to be able to watch them closely and opens up the possibility for items to be stolen, lost, broken or spoil. So, a ratio to watch is Inventory Turnover. How long (usually months) does it take for you to go through your inventory?
- Average Monthly Value of Inventory $____________
- Average Monthly COGS $____________ = Inventory Turnover
- Monthly Value /Avg. Monthly COGS = Avg. months it takes to completely turn over your Inventory.
For Food Services, your inventory will probably turn over a few times a month. For retail, you want to at least turn it over every three to four months. Remember, too much cash in items sitting on the shelves for too long makes you susceptible to waste, theft and just improper management of cash.
Payroll as a % of Revenues
Total payroll (wages, overhead, benefits, work. comp. Ins.)/Total revenues.
IHRSA average is 44.5% for independent clubs.*
Non Dues Revenue as a % of Revenues
Non-dues revenues (all except dues and enrollment fees)/Total revenues.
IHRSA average is 32.4% for independent clubs.*
Deletions of members over 12 months/Average number of members
IHRSA average is 24.5% for independent clubs.*
Earnings Before Interest, Taxes, Depreciation and Amortization (Building Rent/Lease)
Take your net income and add back I,T,D, and A (R if applicable). Then take this and divide by Total Revenues and come up with your EBITDA %. This is a quick statistic that gives you a snapshot of the overall value and strength of the business.
IHRSA average is 15.4% for independent clubs.*
Other Key Indicators (ones I watch closely):
Revenues/Member Visits (Do by Department)
Costs/Member Visits (Especially helpful watching hourly payroll, paper supplies, towels)
I track these for two main reasons:
- It’s something that every department manager should be focused on — grabbing a certain dollar amount for every member visit. Similar to being a store in a mall – the traffic is there, now go out there and get some sales. Now all departments need to work together to bring in traffic, but each one needs to focus on getting people to buy from them on their visits.
- It is very similar from year to year and easy to budget for when you have consistent member visits.
It also stays more consistent than other budgeting techniques when visits fluctuate (due to weather or other unforeseeable circumstances). You can still get sales from the visits you have.
The real value in Key Indicators is that they are comparable to other similar industry operations and also help you to keep an eye on important stats that can quickly affect your bottom line. The key to managing them is to watch them consistently, so as to allow for changes to be made as needed. It is important to manage your business not only by the numbers, but also by it’s pulse.
In most cases, the numbers should support what you already know because you are part of your business each and every day. I am really appreciative of the times I was part of a start up because it taught me to watch every dollar coming in and going out. The trick is to keep focusing on this, even when things are good, because they could always be better.
“Be happy with your business and your successes, but never be satisfied!”
*2016 IHRSA’s Profiles of Success
Larry Conner is the President/GM of Stone Creek Club & Spa. For more information he can be reached at email@example.com.