The Hawkins Method of Accounting

I have ownership in a business with a largely recurring service revenue stream, but also some more typical retail revenue. The service business, as it grows, has a market value, which could be recognized by selling the business.

We have decided along the way to spend considerable sums on marketing in lieu of purchasing competitors, looking at these advertising expenses as customer acquisition costs. In doing so, our P&L looks horrendous, as our current profitability, as represented by traditional accounting methods, is decimated by advertising costs.

We wrestled with how to account for this for internal accounting purposes, looking to account for some portion of advertising costs on a current basis while looking at the balance as more of a business purchase.

What follows is our solution. This solution starts with breaking the business into separate classes, in our case Service, Retail, and Marketing.

We consider what percentage, if any, of our service revenues we believe need to be budgeted to simply stay even. Most service businesses have a natural attrition rate. Thus some level of promotion, perhaps that naturally provided by word of mouth or market presence, but likely including at least some marketing cost, is needed just to stay even. This percentage becomes the budgeted advertising cost, which is then expensed on an Allocated Basis (more on that later) to this part of our business, which we'll call Service.

We then consider what we believe to be sales attributable to advertising, along with the resultant gross margin. Then, considering this, we arrive at a percentage of marketing expense charged to this part of our business, which we'll call Retail.

To make all this work, we allocate our P&L by the aforementioned classes, with revenues and expenses except for marketing flowing through our Service and Retail classes, and all marketing costs flowing through the Marketing class. Then we debit Service the budgeted advertising cost as a percentage of Service revenues, with the offsetting credit to the Marketing class. We then debit the Retail class the allocated percentage of marketing expense, with the offsetting credit again to the Marketing class. This arrives at an Allocated P&L for our Service and Retail classes, which we consider to be a reasonable representation of our ongoing operational profitability.

For the marketing expense that remains in the Marketing class, we then take the beginning combined Allocated P&L, as mentioned above, subtract any additional expense left over in Marketing after the allocations, and then add in the growth in our Service business multipled by a multiple we believe reasonably represents the increased market value due to the increase in the size of our Service business. This all nets to what we call an Accounted P&L, a P&L allocated that then takes into account the additional marketing cost as compared to the resultant increase in value of the business.

This method has helped us analyze our business, considerably. It allows us to get a very clear view of our profitability in a way that matters to us. What are we making on an ongoing basis (Allocated P&L)? How are our marketing efforts working overall? Do our marketing expenditures makes financial sense (Accounted P&L)? For a growing company, these are the kinds of questions that have to be answered, and this system has helped us to quickly and confidently answer them.

This method of accounting may already exist. One would certainly think so. In the off chance, however, that I'm the first to coin it, I'm posting it here for the world to see, and naming it after myself, The Hawkins Accounting Method. If it is called something else, post a correction as a comment. Otherwise kindly refer to it accordingly.