One Blog Post at a Time
Understanding Gross Profit!
We accountants have all these terms: Gross Sales, Gross Profit, Net Income. What the heck? Why can’t we just keep it simple? You just want to know how much money you’re making, how much you have to invest in your business and how much you have to take home, right? Well let’s make it simple!
Gross Sales = How much money you are making.
Gross Profit = How much money you have to invest in your business.
Net Income = How much you have to take home. (We will get to this in the next blog)
Today we are going to talk about Gross Profit & Cost of Goods Sold.
So what’s the deal with GP & COGS and why should you care? Excellent question! There are two ways expenses are classified on a P&L, one as COGS and one as plain ol’ operating expenses.
As Thanksgiving quickly approaches, I’m already thinking about the menu, the guests & the decor. It’s a beautiful time of year. Nothing makes me happier than to have the people I love all together. All the food is placed on the island, the heart of the kitchen, and everyone digs in. In my family, it’s usually a free-for-all after grace. As a host, I make sure that the path of plenty makes sense. What’s does that mean? Well… I want the turkey to be before the stuffing and the mashed potatoes to be before the gravy. See where I’m going with this? I want flow...ease…delight!
The Profit & Loss statement reflects this need for flow. The P&L is the go-to for most business owners. Ultimately, it works everyday to show us exactly where our business is making money or losing it. In order for the statement to work correctly we have to place items appropriately.
Today we are talking about the first item of the proper flow:
Sales & Income
Still confused about the tofurkey? Let me explain...
Have you heard the old adage, "Make hay while the sun shines?" In simplest terms, the equity section of a balance sheet tells us exactly how much hay is in the barn.
This section of the balance sheet is usually the most confusing. Understanding it asks us to be a bit abstract.
Assets are straight forward. Liabilities are too. We know what we own, and we know what we owe.
Equity on the other hand is what our business is worth in accounting terms. (The equity section does not account for Goodwill that has been established.) To determine the true value of your business you would need to speak with a valuation expert.
In the simplest terms, equity accumulates the profit/loss throughout the life of the business, initial investments or injections and amounts withdrawn from the business. The exact way these are handled will depend on the type of entity.
The piper has come to town and he sits squaring in the liability section of your balance sheet. He waits for payments and the day he can leave town.
Liabilities are the amounts owed. This can encompass your light bill to a partner buyout.
Ultimately, the less liabilities, the better, but liabilities aren’t all bad. They make sense when lower interest rates are available. In this scenario, financing frees up cash during asset acquisitions.
Ultimately, it’s all about keeping the piper under control, because he can sneer and make us lose sleep at night if left unattended.
Assets are arranged by liquidity as we talked about in the prior post. Liabilities, on the other hand, are listed based on payback period. Liabilities are merely balances. They do not describe the type of expense. The balance in a liability account is akin to the payoff balance on your car not the car itself.
Acquiring. Consuming. Owning.
In today's society, these are our favorite words. Discussions around many boardroom tables and wine bars center around prepping a budget to include the next asset acquisition.
How do we account for such valuable stuff?
Actually, it’s pretty easy. For most of us, we can get our head around tangible items we can see and touch.
Let's get started!
Assets start the party and come first on the balance sheet. Examples of assets include, cash, accounts receivable (although we haven't received the funds, they are DUE to us,) investments, fixed assets, intangible assets and other assets.
Assets are listed in order of liquidity. Cash is listed at the top because, duh, it is the king of liquidity. Yet land, for example, although extremely valuable, comes much later.
How about I offer you a down and dirty – straight to the point – boiled down version of the seven things you need to know about financials to be the savvy business owner you aspire to be?
Because, let's be honest, most of us aren’t going to raise our hand and volunteer to sit through Accounting 101!
This marks the beginning of a seven-week blog series covering the six major categories found within financial statements. Each week we will go in-depth to clearly identify what you need to know quickly, easily and efficiently to produce the best reports possible.
By understanding the in’s and out’s of each category, you can totally up your accounting game! And doesn't everyone want to do that??
After the series you will:
Week 1: Short Introduction to the Dynamics of the Balance Sheet (BS) & Profit & Loss (P&L)
Balance Sheet Categories
Week 2: Assets
Week 3: Liabilities
Week 4: Owner’s Equity
Profit & Loss Categories
Week 5: Sales
Week 6: Cost of Goods Sold
Week 7: Expenses
Let’s get started on our Week 1 Introduction!
If you change the way you look at things,
Do you feel like you are tackling the same problems every day?
Do you wonder if there is a better way?
Have you looked at the challenge from every angle?
Could you use a new perspective?
These are a few questions to ask yourself as you run your business. It's easy for us, as entrepreneurs, to get lodged in linear thinking.
Linear thinking is:
If you can see your path laid out in front of you step by step, you know it's not your path.
I know what you're thinking. "I'm busy simply trying to RUN my business and extinguish fires every. dang. day! I don't have time for this!" You feel there is no time to sit, dream about the future and write pretty words. You have to bring the future to you. I get it! It's totally human to want to "fix it!" Especially for us Type A's.
But... what if you started to build a house without any plans?
What if you ran to your local home improvement store and started pricing and buying? What if you ran by the paint store on your way to pick up the kids at basketball practice and chose a color for your main living area? Just pick one. There's no time to consider lighting and how it corresponds to your other rooms! (I might have done this!) You see...I didn't want to take time to evaluate the total picture. I needed the room painted. People were waiting on me to pick a color - so this color (YIKES!) would have to do. What inevitably happens in this situation is, unless I get very lucky, I end up disappointed with the results. I didn't stop to contemplate the vision I sought. Now imagine doing this for an entire house? Obtaining a final result you are proud of in this rush-to-action mindset is almost impossible.
We are building here. You are building not only your business but your life. You will spend more waking hours attending to the business of business than you will most anything else. How can that not be important enough to stop, reflect and envision your future?
Who of us has baked a cake - followed all the directions - only to pull the cake out of the oven and see a huge crack down the middle? Our first instinct is to cover it up...
We start to construct the layers and do one of two things:
1. Flip the layer over so the crack doesn't show or
2. Apply enough icing that no one ever knows.
Plenty of icing means yummy goodness all around! No one is the wiser! Yay us! We are going to eat it anyway, right? What's the harm?
This cover up method works great when I'm not at my baking best, but what happens in a business when we simply hide our flaws or cover them with tasty sugar?
Your business is like a cake. You add all the right ingredients - wisdom, know-how, and hard work! You market correctly and that baby bakes. You watch it rise and turn golden brown. You handle your customers very carefully, with great care and integrity and layers start to add up! Then the goodness appears - icing, aka, sales! You feel the sweet relief of your business growing!
One day, although you've baked a thousand cakes, you start to notice issues here and there. You realize that the cake is starting to separate. You are having to hide more - apply more icing.
Hi! It's Bridgett here! Are you ready to take your business to a new level? Let's do it!
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