Trade Spend Analysis: Optimizing Your P&L for Better Financial Health

Trade spend is a critical activity for CPG food and beverage brands, but it creates an accounting challenge for many. Promotional activities involve multiple moving parts, and recording each one accurately is essential to properly accounting for profits and losses — not to mention building a better trade-spend strategy. In this guide, we'll dive into the ways your company can use trade spend analysis to make better financial decisions and improve the health of your P&L.

The Mechanics of Trade Spend in P&L Statements

Trade spend usually includes a variety of expenses, which can create confusion when you go to prepare a profit and loss statement. Many businesses simply place the entire amount into the cost of sales. The trouble is that this method doesn't paint an accurate picture of how trade spend impacts your company's finances.

Some types of trade spend should be netted against revenue on your profit and loss (P&L) statement; other trade expenses impact operational costs. Trade spending that should be recorded against revenue includes anything that reduces the price of the product, such as discounts, rebates, slotting fees, free products, deals, and coupons. In the marketing category, you might include demos, advertising, in-store displays, marketing campaigns, and contests.

This approach to profits and losses gives you a clear idea of where your trade-spend dollars are going. It also helps you understand the true gross profit margin for a given product. After all, when you include your marketing costs that are separate from sales agreements in this calculation, it makes your gross profits seem lower than they actually are. 

Let's say that in a given period, you made $100,000 in revenue. Your cost of goods sold (COGS) is $40,000, and your trade spend is $10,000 (including $3,000 in marketing costs). 

The formula for gross profit margin is:

Total revenue - cost of goods sold / total revenue = Gross profit margin

If you net the entire trade spend against revenue, you'd end up with 50% gross profit margin. 

$100,000 revenue - ($40,000 COGS + $10,000 trade spend) / $100,000 = 0.5

Remove the $3,000 in marketing costs, and your gross profit margin increases to 53%.

$100,000 revenue - ($40,000 COGS - $7,000 trade spend) / $100,000 = 0.53

Recording trade spend accurately makes it easier to compare your company's gross margin to industry benchmarks. It also clarifies the impact of different trade-spend strategies on your profit and loss income statement, which helps you refine your approach. For example, you might notice that in quarters where you spend more on product demos, the gross profit margins increase. Or you might see that a higher marketing spend results in higher revenue.

Advanced Analytical Approaches to Trade Spend

Properly recording trade spend as part of your profits and losses is a step in the right direction. To optimize your trade-spending strategies, however, you'll need to dig a little deeper. Advanced analytics can show how different activities affect your revenue and profit margins — that way, you can spend more on strategies that have the highest return on investment.

Some useful analytical methods include:

• Trend analysis. In a trend analysis, you examine how your company's P&L line items — sales, gross profit and net profit, for example — change from one period to the next. Then, you can look for actionable patterns to help refine your strategy. If you see an increase in sales that corresponds to an increase in slotting fees, it could mean that customers are responding well to prime shelf placements. Don't hesitate to get granular with your analysis; breaking down trade spend helps identify the promotions that are most effective, both at a high level and for individual retailers.

• Variance analysis. This type of analysis compares your financial forecasts to the actual outcomes. To start, use predictive modeling to determine the likely outcome of various trade-spend activities. When the actual numbers become available, you can compare the difference. Investigating variances can help you identify problems and opportunities, so you can develop a more accurate and effective trade-spend program. If you need help with modeling, check out our finance services.

• What-if scenarios. It's impossible to predict the future, but what-if scenarios can help you plan for varying possibilities. With this strategy, you create different forecasts for realistic, optimistic, and pessimistic scenarios. What if one of your major retail partners goes out of business suddenly? What if a large customer doubles their order in the next 6 months? This helps you understand the potential impact on the company's financial performance — and devise a plan of action that shortens your response time when the "what if" becomes a reality.

Advanced analytics are a powerful way to manage trade spend, but the basics are just as important. Before you conduct an effective analysis, you need to master practices including:

• Organization

• Trade-spend categorization

• Detailed trade expense recording

Distributors like UNFI and Kehe send a great deal of paperwork, sometimes weeks to months late. It's critical to have a system in place to coordinate the various types of trade spend. Your system should also account for the ways that trade-spend categories are presented to brands by distributors.

Linking Trade Spend Analysis to Financial Performance

A trade-spend management strategy that includes regular analysis can go a long way toward boosting your company's financial performance metrics, including expenditure optimization and net income.

When you're properly accounting for trade spend, it's easier to understand your true gross margin and contribution margin. It all starts with visibility — robust analytics enable you to dig into the data, right down to individual SKUs, channels and retailers. That way, you can test and measure different strategies to find the most profitable mix for individual products and retailers.

Sophisticated data analysis also reveals valuable opportunities. You might spot cost-saving opportunities or identify products that have an unusually high profit margin. Eliminating unnecessary expenses helps you optimize expenditures, and maximizing profits boosts your net income.

Data-driven management can also help you account for the inherent lag in certain types of trade spend. For example, if your production can't keep pace with a retailer's order, they might not take the deduction until months or even years after the promotion ends. Analytics make it possible to predict lag time and determine when cash reserves might be lowest.

Leveraging Trade Spend Analysis for Enhanced Management of Profits and Losses

Trade spend is notoriously complicated, but with a sophisticated analysis and a detailed management plan, you can stay on top of your company's promotional activities. Over time, this data-driven approach can help you refine the trade strategy and create a healthier P&L. If your company stands to benefit from enhanced analysis, contact our team at Balanced Business Group for personalized consultancy services.