By Dylan Sohie
I need to look into a huge amount of financial data, where do I begin?
Let’s tackle this question by asking some other questions: have you ever realized that cable offers a huge number of channels, but you only watch a few of them? Ever noticed that all of your binge-worthy Netflix delicacies make up only a small percentage of the total shows you have access to? What about the fact that the places you order take-out from make up only a small portion of the restaurants in your area?
While this may just prove you to be boring and unadventurous, you might just be like the rest of the universe.
A 19th CENTURY DISCOVERY
Let me tell you a story. You see, once upon a time there was an Italian man, Vilfredo Pareto, who noticed something that changed the way we look at everything. Apart from just having a name that sounds like a tasty pasta dish, this man was unbelievably observant. Vilfredo noticed that 80% of the total land in Italy was owned by just 20% of the population. Similarly, 80% of total income was earned by a mere 20% of the people. And it wasn’t just economics. Professor Pareto observed 80% of the healthy peas in his garden were grown by just 20% of the plants, and that 80% of his beard grew from only 20% of the surface area on his face.
Okay, I made that last part up. He didn’t notice it, but the rest of us do.
21st CENTURY EXAMPLES
Anyway, he summarized this observation, the Pareto Principle as it came to be known, by stating that roughly 80% of the effect comes from just 20% of the causes. And if you didn’t know this already, this principle is used all over the place. Here is a small list to blow your mind:
- In 1989, the richest 20% of the population accounted for 82.7% of GDP.
- In Occupational health and safety, professionals assumed 20% of safety hazards account for 80% of the injuries.
- In Computer Science, 20% of the code accounts for 80% of the errors.
- Studies have shown that 80% of crimes are committed by 20% of criminals.
HOW YOU CAN BENEFIT
In short, the world seems to run on the 80/20 rule, and your business is no exception. As we look into our client’s books, we notice the Pareto Principle working all the time. The largest portion of income is earned from a handful of clients, most expenses are often attributed to just a few vendors, and the vast majority of inaccuracies will be made up of only a small percentage of total transactions.
From an efficiency standpoint, most small companies just don’t have the accounting resources to do a complete audit of all of their clients or vendors. The 80/20 rule saves you from needing to. Here are some practical tips to consider:
- For instance, let’s say you experience a drop in sales, and you can’t get to the bottom of it. You feel overwhelmed by the number of sales transactions, or your client list is just too big to go through, just start from the top. Your customers are not all created equal. A great, easy method to analyze your sales trends is by sorting your customer list by total sales over the time-period that concerns you and just looking at the trends of the top 20% of them. Chances are, the problem lies at the top instead of the bottom.
- This is helpful for growth, too. If most of your sales comes from a small number of clients, you can give them a proportional amount of TLC. Or maybe you could try pushing some of the customers in the bottom 80% into the top 20%.
- The same works for your outs as well as your ins. Let’s say you experience an unexpected growth in expenses. Looking at the top 20% of your vendors will help find the leak.
Basically, you will probably be a lot less intimidated by your financial data if you stop counting by ones and start counting by top-twenties.
So here is an encouragement: your needle isn’t in the haystack. It’s probably just sitting on top of it.
Dylan Sohie is a Senior Accountant with Omega Accounting Solutions, a fractional accounting firm. Dylan was born in New York, raised in California, and holds dual citizenship with Great Britain and the United States. When he’s not buried in SUMIFs, he can often be found entertaining others with the guitar.
Omega Accounting Solutions empower small business owners to make informed business decisions through the production of accurate and timely books, that yield honest and insightful reports, all while leveraging the assets within the business, and Omega to maximize efficiency. They build long term relationships and partnerships between staff and clients, recognizing each relationship as an investment.