In this series on the elements of your financial statements we’ve looked at the income, cost of sales and gross profit, all parts of the selling aspect of your business. Today, we’re going to look at the operational side – the costs associated with the infrastructure that enables you to sell your product.

In the olden days, the travelling salesman’s operating costs consisted of his mode of transport and his suitcase full of products. Nowadays, the costs of running a business are much greater, and grow as your business grows, to support the increased sales volume. Operating costs can fall into one of the following categories:

• Physical infrastructure – costs relating to the office, the warehouse or the shop, costs relating to vehicles and other assets, as well as the costs associated with running the machines and equipment used to produce your product or service
• Human infrastructure – the people costs, not just salaries, but welfare and development as well
• Protection of the infrastructure and assets – such as insurance, security, data storage, liability cover
• Compliance requirements – the cost of complying with accounting requirements, labour laws and SARS legislation, as well as governance rules
• General running costs – the cost of items consumed by the process of running the business, such as telephone, data, stationery, food, amongst a host of others
• Growth activities – costs associated with plans to grow sales and the business could include marketing, consulting, and anything else that the strategy requires

Operating costs are the first area to come under the microscope when the business profits need improvement. While there are sometimes a number of areas that can be reduced, there are also some critical elements. It is short-sighted to skimp on the maintenance of the equipment to save on costs when replacing the equipment is a much higher cost, for example.

Do you know what it really costs you to run your business? Do you know what the monthly operating costs are that need to be covered without fail? If you’d like a better insight into your business give us a call to walk you through the information available.

Profit is a fond topic for most business owners, but do you know the difference between gross profit and net profit? Gross profit is the net result of your sales and your cost of sales, in other words, the profit on the sale of your product. Net profit, is the larger gross profit less all other operating and financing costs, usually a fraction of your gross profit!

Gross profit can be calculated for various elements that make up the total sales of your business, such as the gross profit per product or product category. The total gross profit in your financial statements depends on the number of products you sell but doesn’t show you the amount of profit you are making per item sold. Most accounting packages have this information in one of the stock/item reports. It is very helpful to analyse the gross profit per stock item, as you can see which products make you the most money, and therefore what you should focus your sales effort on.

The same principle can be applied to business divisions. By calculating the gross profit per area you are able to see who is pulling their weight and who is not contributing enough towards the running costs of the company. For service businesses, it is also possible to calculate the gross profit per service by including the salaries of the staff, and other costs, into the calculation. Typically service businesses keep some form of timekeeping, where it is possible to see how much of a person’s time (and therefore cost) can be allocated to the various services they perform, even better if individual staff members can be allocated to a specific service. Accounting packages are not set up for this level of analysis, so a spreadsheet is often necessary.

It may be easier to understand the gross profit as a percentage of sales rather than a rand value. Knowing that a product makes an R5 gross profit doesn’t have as much meaning as knowing that the gross profit is 75% of the sales price. Using percentages, you are also able to compare products and the value that they add to the operations of the business.

It may be necessary to dig a little into the accounting information to get a real picture of the gross profit of the business. Should you need a spade or a little help digging, let us know.

 GP – service GP, per product, overall, per division – % vs rand

Last week we looked at income and the various types of income as part of our mini-series on the elements of your financial statements. Today we’re looking at a very misunderstood area – the cost of sales.

Many people think that cost of sales is the cost of the goods you have bought (or made) to sell to customers. It is not – the cost of sales is the cost of each product that has actually been sold. This means that if you have paid a supplier for stock, that is not yet sold, the cost won’t be included in the cost of sales.

This is important because of where the cost of sales is reflected in the financial statements. Cost of sales is an expense which reduces your profit, and therefore your tax. Thus it should not be overstated, by reflecting all the purchases during the year. The cost should match the sales, in other words, if you sold 10 items, the sales price for those items shows as income, and the cost of those 10 items shows as an expense. The cost of any unsold items sits on the balance sheet as stock on hand.

What if you don’t sell stock, what if you offer a service? Then according to the accounting definition, you DO NOT have any cost of sales. However, this is where pure accounting and the needs of management differ.

The real cost of making the sale may include any number of expenses depending on your business. For example; a service business may consider their technical staff to be a cost of making sales. What about travel and entertainment? Management reporting could include all of these expenses as the cost of sales to help understand how the business makes money and how well it is doing that. No-one said that the management reports needed to be in the same format as the annual financial statements. The accountants can re-classify the expenses for compliance purposes, as long as management has the necessary information to make decisions.

Next week we’ll look at the net result of sales and cost of sales, gross profit.

If you’re not getting the information you need from your management reports, perhaps they read too much like an accountants report, give us a call to help you re-format them into something useful