All in One or by Department

One of the more important decisions to make regarding Indirect Expenses is whether to set up one set of accounts that represent the Indirect Expenses for the company as a whole, or to set up specific accounts by department.

It may seem counter-intuitive to set up Indirect Expenses such as payroll, office expenses, travel, meals, etc. for multiple departments. The decision to do this or not should be based on the stories that you want your financials to reflect.

For example, when you put all of your Indirect Expenses with no separation by department, it may provide more difficult (not impossible) to pull the stories out of your P&L reports to examine specific expenses for things like marketing, sales, or customer service. This might limit your ability to get the full story on ROI for specific activities or to follow trends.

Let’s take a quick look at both approaches to bring some clarity to this discussion.

Figure 1 is an example of creating your Indirect Expense accounts with no distinction of departments.

Figure 1 – Example of Indirect G&A Expense Accounts for Whole Company

This is not meant to be a complete list of the GL accounts you might record. This is just a list for this discussion. In this example, all of the payroll expenses are recorded together. This would mean if you want to examine some specific payroll areas to determine what you are spending on say, marketing personnel, or sales personnel, you would need to create and review reports that provide that detail. From your overall P&L view, this story would not be immediately apparent.

The same would be true if you are trying to review the story of specific expenses related to travel or meals. If you wanted to dig into that story to see where some of the variances are occurring, your overall P&L would not give you the level of detail to do this more easily.

That is not necessarily a bad thing. When you have a relatively small business, you are probably very aware of where money is being spent on a regular basis. However, as you grow, this particular organization of your Indirect Expenses may not serve you as well.

A different approach is captured in Figure 2. Please note that I am deliberately leaving out categories and just noting that with the “ – – – “ since we are not examining specific categories as much as organization.

Figure 2 – Example of Indirect Expenses by Department

In this example, Indirect Expenses are organized into four departments – customer service, marketing, sales, and all other.

Using this model, the expense story of each major structure in your organization is more apparent. This allows particular accounts become more meaningful. For example, seeing commissions/bonuses in the sales department, instead of as just one entry for ALL departments, make it easier to see your current trend on those expenses directly related to sales.

This “by department” method not only helps you immediately see trends by department (e.g., individual department expenses as a percentage of sales at a trend), but it also gives you the ability to track expenses that are unique to particular departments.

Notice that every department does not have to include the same accounts. For example, in the marketing department, there are GL accounts for marketing/advertising expenses and trade show expenses. Those expenses are unique to marketing and only recorded there.

Generally speaking, the “all other” department would be true overhead expenses (e.g., cross functional management, rent, utilities, technology not related to one department). Using this “by department” method gives you much deeper information on cost management and the return on investment of specific investments by department. We will discuss this more as we move into the reporting part of this series.

Allocation or only whole people?

A very logical question you will face if you determine you want to organize your accounts by department is how to handle payroll accounts for people that may do work in more than one department. This is the downside of the departmental reporting method. However, the key is making a decision and being consistent.

True overhead personnel (those that are truly responsible for broad areas of your business (like you) should be placed in the “All other” department. Normally it is not useful to try and breakdown the time spent by each of these people on any regular basis for reporting them by department.

However, for those individuals that either perform duties in only one department exclusively or those that it is easy to calculate a consistent percentage of time spent in two departments (e.g., a marketing/sales assistant, a marketing/sales manager), just pick a percentage based on your best estimate and stick to it. This means that your accountant will record their payroll expense and then create journal entries to correctly allocate to departments by percentage for reporting purposes.

The Rule of Few

One last guideline to keep in mind when creating your Indirect (G&A) expenses accounts is what I call the “rule of few.” Your goal should be to create the fewest number of accounts required without sacrificing clarity and without sacrificing an ability to dig into specific story lines that may be significant to track.

For example, let’s start with how you might track Marketing/Advertising expenses. One option is to set up a single GL account called “marketing/advertising” as I am showing below.

You could record all marketing expenses into this single account and at any time you can track your marketing story by examining the trends of this account. That is certainly few, but likely not enough detail to provide the full story.

There are different types of marketing/advertising that lead to specific stories you want to know. For example, the following might be a better level of details for accounts within Marketing/Advertising:

This provides the ability to track any consulting and hosting fees separately from specific advertising or PPC (Pay per click – usually Google AdWord) marketing you may be expensing. Hosting is likely fixed, so watching that expense may not be much of a story. However, examining how expenses relating to professional services or specific forms of advertising relate to changes in revenue might create a story to follow.

There are certainly plenty of Indirect Expense accounts that require only one primary account code (e.g., rent, utilities, legal fees, Insurance) but there are several where it may be useful to have both the total and more detail (e.g., travel, payroll, office expenses).

Follow the rule of few and you will keep things clean.

On to the Stories your Financials Reveal

As stated in the first article in this series, my plan in writing this series is to dive deeply into what you need to know as a CEO to build the right reports and to understand the stories of past, present, and business yet to come that your financial reporting offers you. The first three installments on the General Ledger were an important foundation, and now we are ready to start discussing real stories that your financials tell you, such as:

• The role of the monthly P&L report, budget report, forecast report, etal.
• How percentages paint the visuals your story requires
• Financial reports and financial KPIs – is there a difference?
• COGS (Cost of Goods Sold), gross margins and the pricing story
• Building “proformas” that mix truth with “other” truth or the unknown
• Capital and Operating, one-time events, and all that “ITDA” of “EBITDA”

I welcome you to follow the series in my newsletter (From EtoC Newsletter signup here if you are not a subscriber) or on this blog.