Two-Story PnL deck

(C) Sergiy Kuzmenko, 2019-2020, Kyiv 1
New Project Profitability method
for Fixed price and T&M mix
with shared resources and a bench
Theory & case-study
Two-story Profit and Loss report
Management accounting
IT/Software development

Speaker / author — Sergiy Kuzmenko, 15+ years of managerial
experience in IT, 10+ years owned / analyzed PnLs
Guest / client — Serhii Denysenko, at the moment of presentation
— CEO of Lenal company (40+ developers), with 500+ E-commerce/
CRM projects delivered during 10+ years, including big-scale ones,
https://lenal.eu/
Q&A session will follow after the main part.
#TwoStoryPnL
Two-story Profit and Loss report

20+ developers / 5+ projects — time to assess
and compare regularly:
●
Clients - where we earn, and where actually
lose time and money
●
Developers — their contribution to “gross
profit” versus “expenses” (a joke —
“management always knows that cutting 1/10
of the workforce wouldn’t affect productivity,
but unfortunately doesn’t know which exactly
1/10”)
Otherwise, the business is at risk of overlooking
problems, and - loss of profitability.
Business grows - focus might blur

Financial responsibility centers (FRC):
●
Profit center
●
Investment center
*) “Profit center” - coined in by Peter Drucker in 1945,
Investopedia.com
Management accounting instruments
(?) Dear audience, please raise your hands if you use the instruments! Thanks.
For us to be on the same page with the crucial concept, couple of examples:

Type of fruit City
Bananas Kyiv
Lemons Odesa
Peaches Lviv
Revenue Costs Profit
Month 1 10000 9750 250 2.5%
Month 2 15000 14000 1000 6.7%
Month 3 8000 8100 -100 -1.3%
3.5%
Example 1: fruit retailer network
Overall results give us little information for decision-making
(we can maybe compare averaged monthly profitability with the bank interest rate)

Kyiv Odesa Lviv
Month 1 500 -150 -100
Month 2 850 -250 400
Month 3 400 -280 -220
●
Kyiv — good job!
●
Odesa — close?
●
Lviv — investigate
Profit per location reported by Financial Analyst: Managerial conclusions:
Structured report -
highlights achievements and problems
(?) Dear audience, your ideas:
Why our financial analyst structured the profitability report in this way?..

Company (investor, brand)
Odesa Kyiv Lviv
City Manager makes decisions:
* Fruits to sell
* Shops design
* Stuff management
* Suppliers / procurement
* Local advertising
The added value is created “in cities”
Shop 1 Shop 2 ......
●
PnL — manager’s success “speedometer”
●
If we pay manager’s bonus as % of his financial
responsibility center’s result:
Goals of company and manager are aligned

Goods:
* Tents with solar batteries and rain water collectors
* E-books readers ideal for use in underground trains
* Funny hats for kids with GPS tracker
Revenue Cost Margin
Month 1 10000 9750 250 2.5%
Month 2 15000 14000 1000 6.7%
Month 3 8000 8100 -100 -1.3%
3.5%
Example 2 — “niche” goods distribution
The same numbers, different business-model

E-readers Tents Hats
Month 1 100 150 0
Month 2 0 200 800
Month 3 -100 100 -100
Margin per goods type: Probable conclusions:
●
Tents — stable profitable
●
E-readers — “so so”
●
Hats – high profit / unstable
(seasonal?)
Structured report -
food for managerial decisions

Company (investor, brand)
E-readers Tents Hats
Logistics, Retail sales, ...
●
Each type of goods -
unique market niche
●
Promotion budgets and channels
— parents, tourists, passengers
●
Work with Vendor, import
●
Outsourced (dealers)
●
Standardized
Added value created in “goods departments”

●
Correspond to org structure / zones of responsibility
●
Separable: results aren’t directly dependent on neighbours
●
"Reasonable" / the numbers "make sense"
Centers allocation requirements

Acquiring the Structure
It makes sense to structure business in a way that allows meaningful financial
responsibility centers allocation. TwoStoryPnL suits to the Matrix org-structure
(?) Dear
audience,
have you
met
companies
at stage 2
or 3?

Human capital
Recruit / grow / breed resources
(offices, departments, teams)
Projects delivery
Arrange work and monetize results
(projects, accounts, products)
Line / regional manager Project manager
“Growing” resources “Using” resources
Long-term, 2-10 years Short mid-term, 1 month - 2 years
Invest in trainings and offices Clients relationship
HR dept Sales
Out-staffing partner
(developers for rent)
<- extreme->
forms
Sub-contractor intermediary
(no own developers)
Software Company - dual nature of business
+

1-story methods of centers allocation
“by resources”: “by projects”: SILO:
Center = office, or
department / team
Center = client, or
project / product
Totally separated parts,
clients / projects not shared,
Center = a part
Report
Kyiv — X
Lviv — Y
Odesa — Z
....
Report
Account1 - X
Account2 - Y
....
Usually, to the best of the author’s experience, Software companies structure
their financial results report using one of the above “plain” methods

“1-story” structuring: by resources
Suits Pros Cons
T&M: given
external rate for
developer time
Bench cost
is allocated
logically
●
Fixed Price - ? need to split Revenue somehow
●
Office/department managers “drive” strategy
●
Projects’ profitability not seen, sales tend to
“promise everything” then blame delivery
Gross margin
Team A Project 1
Team A
Team B
Project 2
Report
Kyiv — X
Lviv — Y
Odesa — Z

Suits Pros Cons
Fixed
Price,
mix of
pricing
models
Logical
allocation of
Client
relationship /
Presale costs
●
Cost of shared / partly involved resource time?
“factual”-> projects interfere; “past” -> information lost.
●
Sales managers drive strategy -> human capital under-
invested -> chronic lack of resources
●
Bench — company expense? Who is responsible
●
Projects lifetimes are different, how to report monthly?
Gross margin
Team A
Project 1
Team B
Team C
Project 2
Report
Client1 - X
Client2 - Y
....
“1-story” structuring: by projects

Suits Pros Cons
Really big
companies
(parts >150hc)
Any pricing models ●
Wall: - hard to document “resources
sharing” between SILO parts, by design
●
Bench in one part, lack of resources
nearby — not rare situation, as a result
Team A Project 1
Team A
Team B
Project 2
“1-story” structuring: SILO

Fixed Price T&MOut-staffing
Project A
Project C
Project B Project D
Project E
Project F
Project G
Project H
Team 1 Team 2
. . .
Lenal organizational structure: not “1-story”

Can we?
Gross margin
Team A Project 1
Team A
Team B
Project 2
Teams <-- profit centers --> Projects

Chosen: “2-story” method

Project A Project CProject B
Team 1 Team 2
Transfer (internal) prices for pieces of work
RM RM
PM
Project profit = “External” revenue — “internal cost”
(sum of pieces of accepted work at transfer prices)
Revenue recognition = client accepted + paid
Win recipe:
Sell at higher price / consume less pieces
PM PM
Team profit = “internal cost” of accepted pieces of work
- resources’ related expenses (salaries, taxes, rent, ...)
Revenue recognition = monthly, pieces accepted by PMs
Win recipe:
High utilization / smart salary control
“Internal pricing policy”-
long-term company strategy
“Under the hood”: Transfer pricing

Implementation of “2-story PnL” in Lenal
●
2-story structure is “not intuitive” to many people (time, educate)
●
Automation or reports generation is not trivial
●
Project and team managers saw results of their decisions real-time
●
Better balance of interests “company - managers - employees”
●
1/3 of profit-driving clients were identified
●
Resource financial KPI for salary review and staff reduction decisions
●
Qualify of managers’ decision-making improved
●
Net income of company grew

If a geographically spread Software company adopts the
Two-Story PnL, and introduce global internal (transfer)
price policy, its Software Development Centers will be the
“pools of resources”, and their “gross-margin” profitability
will depend on:
●
local payroll taxes, paid vacation / sick leave norms
●
office rental prices
●
resources availability at the job market
●
salaries level, skills, loyalty
●
regional management efforts
and will not depend directly on:
●
projects results
Further use: compare offices profitability

●
Long-term investments — employees learning
programs, office design and improvement,
University training centers — valid Strategy
instruments
●
ROI analysis (report to stakeholders, compare
locations profitability)
●
Business-plan language: managers will request
investments providing their forecasts of future
financial results (commitment)
●
Investment performance analysis: compare
future factual financial KPIs with the planned and
the previous ones
Further use: offices — investment centers

Thank you!
Q & A
Contacts:
●
Method, practices – management consultant Sergiy Kuzmenko (FB, LI)
●
Automation — refer to Lenal CEO Serhii Denysenko (FB, LI)
●
this presentation’s FB event and video recording (FB, youtube)

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