Financials That Count: Where Do You Really Make Your Money?

You probably get a lot of financial reports: monthly income statements and balance sheets, sales reports, expense trends, and so on. But are you getting the one that really matters? I'm talking about Profit by Segment/Line of Business.

Most profit reports that we see are broad; typically they cover the whole company, or in bigger companies a division. We do get more detailed reports -- sales by product line or territory, or expenses by department -- but they don't tell us about profitability.

These reports never truly answer a very obvious, and very important, question: "Where do you really make your money?"

Let's acknowledge a fact of life for companies small and large: There are probably parts of your business that are quite profitable, some that lose money, and others that are just so-so. While you no doubt have some intuition here, you probably don't really know how big the differences are.

You know that not all products are equally attractive, based on their gross margins. However, their true contribution to your bottom line goes beyond that. Maybe your high-margin products require a lot of after-sale service and support, or a long sales cycle. And of course, the actual price for a particular product probably varies by customer or channel.

The same is true for customers. Think about the mix of products they buy, the sales effort required to sell to them, the logistics expense of supplying their locations, as well as the impact of competitive pricing.

So, how do you get started? First, you need to identify the critical differences that affect profitability. For products, it might be high volume versus specialty, hardware versus software, or products versus services. The more revealing distinction, though, will come by segmenting customers in terms of how they behave and how you service them (e.g. strategic accounts versus industrial customers and distributors).

Then, create a matrix where the rows (products) and columns (customers) reflect these differences. Each cell represents a particular set of customers buying a particular set of products -- a "mini-business." Don't make this too big: a five by five matrix should be the max, and for many businesses, two by two is very insightful. Start simple, and get more complicated only if you need to.

Once you have your matrix, start populating the cells. Start with revenue. Don't average prices -- you want to capture the differences in what different customers pay for the same product. Product cost and other cost of goods sold by product get you to gross margin dollars in each cell. Then divvy up expenses for sales, marketing, logistics, and other functions, which would vary by row or column distinctions. Get as close as you can to nailing down your operating income.

This will take a few iterations to get right, but you will be surprised at the insights. You will find segments that you want to get rid of, segments that you want to invest in, and probably a number of products that you want to reprice and see how the market reacts.