When I begin a consulting or coaching engagement with a company, I always revamp the financial reports provided by the CEO. The client reporting is extremely confusing, if not completely unreadable, in almost every instance. They lack any meaningful information and are impossible to take action on.
I have several basic tenets of report design, including above- and below-the-fold reporting, especially on the P&L. After I explained the concept to a podcast host, he had never heard of it. Accordingly, I believe it’s time to talk about this concept, which gives more meaning to those monthly income statements you read each month.
A Quick Caveat: I Prefer Throughput Reporting
You’ll see some terminology and a presentation you may not be used to in the examples I will show you. I’ll provide some cursory definitions, and that’s all. The focus of this discussion is to point out above and below-the-fold P&L reporting with examples. The concepts apply to governmental fund reporting, GAAP reporting, and any other type of financial reporting.
However, here are a few quick definitions of some terms I’ll be using:
Throughput – revenue less extremely variable cost. I prefer the term financial throughout but the shorter term in presentations.
DCR – (extremely) direct cost of revenue.
OE – operating expense.
OCF – operating cash flow. I never use EBITDA because it’s not a substitute for operating or free cash flow.
tpRate is my abbreviation for throughput rate, and it’s throughput divided by revenue.
ROI is the return on investment, whereas, in asset-intensive businesses, investment is the sum of gross fixed assets and net working capital. ROI is OCF divided by investment.
Debt Coverage – OCF divided by debt service (principal payments only).
My made-up company brews beer and sells it through a comprehensive distributorship, as shown in the example that follows in this brief essay. All numbers are in thousands unless otherwise noted. For instance, rBBL is the average rate or revenue per beer barrel.
If you are an expert in this industry, I apologize for using BBL vs. CE. I find BBL counts easier to absorb, but that is preference only.
Let’s Talk Folds in Your P&L Reporting
The younger generation of web designers may think above the fold, and below the fold only applies to the home pages of a website. The terms have their roots in the newspaper industry, where many papers used to be folded in thirds. When I was a Controller/CFO for a newspaper publisher, we used half folds, meaning there was one fold in the middle of the newspaper.
Common sense will tell us any content above the fold is the most important material a publisher wants a reader to read. Above-the-fold reading material should be easy to grasp quickly and cause the reader to keep reading, in this case, below the fold.
In my P&L layout, I’m not strictly adhering to these definitions, whether we’re talking newspapers or websites. I’m borrowing the terminology because I believe it’s sticky in a financial reporting context. Plus, naming conventions are useful when I’m describing numbers above or below the fold to another person. CEOs I work with know exactly what I’m referring to.
In the first image below, I have a blank P&L canvas. I’ve excluded numbers for now because I don’t want them distracting from my explanations.
You will notice three sections:
- The top third is what I call Above the Fold. I include (in my opinion) the most important metadata that provides substance and insights into the P&L direction below it.
- The bottom third is what I call Below the Fold. I view financial statements as a system, not a system of parts, but one big part that is tightly integrated. My systems thinking sways the metadata I include Below the Fold. As defined earlier, you will likely find OCF, throughput ROI, and debt service coverage. In smaller private businesses, I include unfunded tax liability.
- The middle section is the P&L or the hamburger between the folds.
When all three elements above are included in one report, any business leader can grasp the big picture quickly. This is also my preferred method of reporting for Board members, including a meaningful balance sheet using the same elements above.
Let’s take a look:
You’ll see a final version with numbers in the next section. Do not get hung up on the column or row headings. In ‘real’ reporting, my column headings will be by year, where I can toggle between YTD and Trailing 12 Months.
Since all of my client reporting is located in a financial model, we can easily drill down, drill through, drill across, or do any other type of analysis we choose to do. Mission number one is to reveal a front page that’s readable and actionable. We want reporting that will generate questions leading to action, whatever it may be.
Before moving on, if you like the concept, don’t allow yourself to be constrained by my row classifications above. While this sounds inefficient, I start with a blank canvas on every report design, even if it’s an industry I’ve worked on before. That keeps me from getting tunnel vision. Plus, my curiosity drives what I include above and below the fold.
Think like a CEO. Think like an investor. Think like a banker. My folds may vary depending on the reader, even for the same industry.
A Brewing Reporting Example
Below is an example of what I’ve described above. Numbers are in thousands except for rBBL (rate per barrel). The numbers are loosely based on Boston Beer’s historical results with some modifications.
Remember, the bigger point is injecting above and below-the-fold metadata to give financial readers a fuller picture of the performance depicted in this financial reporting. The P&L section between the folds is left to your discretion regarding whether you want to include more detail.
If the CEO of a small brewer were to see this reporting quarterly, would they get the bigger picture faster than if they were reading, standard reporting cranked out from the company’s ERP system?
One of the greatest copywriters ever told us, “You need to enter the conversation already taking place in the customer’s mind.” This Robert Collier line is the driving force to the fold on top and the fold on bottom in the snapshot P&L summary above. In short, two questions need to be answered before creating the folds:
- What’s the main thing or the main question that needs to be answered with minimal thought required by the readers?
- Are we creating a holistic view of the business in both folds?
Incidentally, I also use the folds on balance sheets. I’ve been observing financial huddles since 1991, and I’ve never seen a concise and meaningful presentation of balance sheet data. It’s as though the balance sheet does not exist. If you are a financial statement guru, you may have noticed that I’ve incorporated balance sheet numbers in my lower fold above, sticking to concise and meaningful boundaries.
Before moving on, I want to highlight one measure on the lower fold. If I were designing a rewards program for an executive management team, I’d start with ROI (I also call it return on assets management or ROAM). The denominator should also be a gross number, excluding accumulated depreciation.
Financial rewards should not kick in unless a certain ROI hurdle has been exceeded. That’s because ROI is the most holistic measure to gauge the success of an executive leadership team. Competent executive leadership teams can excel in sales or OCF. Still, great teams in an asset-intensive business know how to maximize their investment in ways that weaker executive teams cannot. ROI takes into consideration marketing, sales, operations, and post-sales support. Please do not take NOI lightly in an asset-intensive business.
My Rationale for the Folds
During small group speaking engagements, I ask audience members about the most important financial statement. I ask the same question to every accounting department that I encounter.
Many say the P&L, and a few say the balance sheet, which surprises me a little. And only a handful ever mention cash flows. I suppose no one has ever been in a turnaround situation before. You can probably guess what the number one answer is from CEOs. The P&L.
I view the financials as an integrated system. Just like three parts of the human mind are tightly integrated, that’s the case for financials. I never like to view them in parts but rather as a whole, even if I’m looking at one of the primary statements, like the P&L.
Stephen Krug is the author of Don’t Make Me Think. I see far too many financial reports where I’m left to think far too hard. If that’s true for a seasoned financial analyst, how does this reporting work for non-financial statement experts? The goal of the folds is to apply some of Krug’s advice in helping the reader not have to expend too many brain calories to understand the numbers.
Let’s refer back to our P&L snapshot from above. When I see a P&L generating seemingly high earnings with consistent growth, are we generating positive cash flows? Are we still able to cover our debt payment with ample margin? If ROI is low, do we have a marketing problem (we get the answer quickly by looking at utilization above the fold)?
Above the fold, I want context before I even see revenue. If I see the throughput rate remaining consistent but the gross margin dropping, seeing the utilization percentage above the fold confirms the brewer is operating below capacity. Above and below-the-fold metadata keeps me from having to think too much.
I love the book The Invisible Gorilla by Chabris and Simon. They are the authors of the famous psychology test on selective attention. If you have not seen the video that spawned their insights and conclusions on intentional blindness, take a watch:
In the book, the authors state that 75% of viewers of this video are convinced they would have seen the gorilla. In reality, about 50% miss the gorilla entirely. When they return to rewatch the video, they claim they cannot believe they missed it.
Does intentional blindness exist with readers of financial statements? Yes, if the statements are in a standard format taught in accounting courses and those spit out from standard reporting templates in small and large ERP solutions.
By now, you should know that a healthy or growing bottom line may not tell the entire picture. What if the utilization of key assets is still low? What if an unfunded tax liability could break the bank despite strong profits? What if our operating cash flow coverage ratio starts to dip below 1.0?
Many of the CEOs I have worked with over the years have been great at turning $3 million organizations into $25, $50, $75, and even $100+ million organizations. Yet, they each share a financial gene that is nearly impossible to destroy. They are overly focused on sales and the bottom line. Above and below-the-fold information is either lacking or their financial people have not helped them to connect the dots between what matters and those two numbers they care about the most.
Holistic thinking is nonexistent because of inattential blindness. I did not know this term existed until I saw the gorilla video, so I didn’t have a name for my frustration that led me to create above and below-the-fold reporting.
I have no scientific proof that above and below-the-fold reporting will eliminate (financial) intentional blindness. Still, I perceive this reporting inclusion as a positive step in the right direction.
Take Krug’s advice, and let’s learn from the invisible gorilla. Don’t make your readers think too hard by helping them to see the invisible. Use the folds. Need help? Let’s chat.