The Four Wall Analysis
The Four Wall Analysis
Running a business is challenging. Owners are dependent on countless unknowns. They are unsure of what the customer base will do over the next year. They are unaware of how committed employees will be while they are at work. They do not know if wholesalers will change their prices. All of these unknowns can make business owners feel like this is the status quo of a business and it must be accepted; because of all of the unknowns, they should simply wait for the end of the month to see what profit and loss their accountant finds and just accept it. This is not the case. Instead, they should try the four wall analysis.
What Is The Four Wall Analysis
The four wall analysis is a way to manage a business’ profits and losses, rather than just review and accept them. At its core, it is a method for comparing four different revenue scenarios. The point of doing this is to better understand what drives profitability. All of the revenue scenarios used are proforma. In other words, they are potential projected revenues that the business could have. The business owner then lays out what the profits and losses would look like at those revenues. When the owner compares the losses across the four projections, they can identify ways that they can better control their expenses. In other words, where they and their employees should concentrate their efforts in order to increase profits.
How To Do A Four Wall Analysis
For every retail store, a four wall analysis will look a little different. However, generally speaking, they follow the same recipe. Here are the basic steps to putting the analysis together:
- Choose four different projected annual sales revenues and put them in four different columns.
- Divide this by twelve and state the monthly sales under the annual sales revenue.
- The next section should cover the monthly cost of goods or services sold. Each line should break down the various costs that were created from the actual sales. For a retail store, this will likely be the wholesale cost of the products sold, the cost of labor (this is a variable cost that is based on the volume—i.e. if more is being sold, a store operator would potentially need to pay for more labor), and the additional paper and materials used (if more was sold, more bags would be used in the checkout process, more receipts would be printed, etc.). Add all of these line items up to show the total monthly cost of goods sold.
- In the next section, subtract the monthly cost of goods sold from monthly sales. This will give the gross profit.
- Next is the monthly expenses. These will vary from business to business. However, it is important to identify which expenses are fixed and which are variable. Generally, the fixed expenses are rent, communications, insurance, and licenses or fees. Variable expenses may include utilities, marketing, and advertising. There will also be some nominal expenses, such as repairs and maintenance, office supplies, printing, and miscellaneous items. These are important to note, though.
- Add all of these line items up to show the total monthly expenses.
- Subtract the total monthly expenses from the gross profit to find the net monthly profit. Multiply this by twelve to get the net annual profit.
After these calculations have been made, the owner can analyze the results. They can pinpoint areas where their business could reduce waste and strategize ways to drive profitability. In short, this snapshot of potential revenues provides enough detail to encourage better management, but not so much detail that all that is created is confusion and unnecessary data.
Benefits Of The Four Wall Analysis
1. Company-Wide Buy-In
It can be difficult to get employees on-board with a change. Even if leadership states that the change will help the business. However, when you show them the numbers and the difference that their actions and changes in behavior could make, you will see employees starting to take ownership. They will begin to understand that they can contribute to the success of the business and the potential for the business’ growth and expansion. Without these numbers being being laid out, however, it is likely that employees will remain more than just unaware and indifferent, but also potentially opposed to changes that would reduce losses and increase profits.
2. Fewer Surprises
Each projected revenue comes with a list of corresponding profits and expenses. If you set a revenue goal for the business, you know what you can expect the utility bill to be for the month. You also know how many more plastic bags or rolls of receipt paper you need to order. You can manage the schedule more effectively. You can also track each and every expense and profit at the end of every month to make sure things are on track to reach the annual goal.
3. Increased Precision
To some business owners the four wall analysis might at first seem too general to provide detailed insight. However, it is important for you to understand that this is to enable you to see the bigger picture. Once you have the broader understanding, you can add more line items. You can become more and more specific. You can identify the variable expenses that can be managed and the fixed expenses that can be negotiated down. Then, you can scrub every single line item to find out where and how costs can be reduced. You might find that at certain hours you do not need as many employees on the floor. Alternatively, you could identify that the staff could put more items into shopping bags so that fewer would need to be ordered every month. Although it might first appear as only a dollar here and a few cents there, managing the analysis line by line will help you cut expenses significantly in the long-term.
Small but growing business owners need to stop thinking like small businesses. They need to start expanding their strategies like they are trying to expand their operation. In order to do this, they need to use the exact same approaches that corporates and larger organizations use. These approaches, when boiled down, provide a solid foundation for growth and can significantly benefit smaller merchants. The four wall analysis is the perfect place to start.
How could your business benefit from cutting costs? To find out more, please contact us.