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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.
There is a difference and it’s an important one. Every account within your COGS category should be associated directly with what you are in business to perform. For example, if you build houses then COGS should include your hired labor, your materials, permit fees, dumpster fees, etc.
An excellent question to ask yourself is, “Would I have this cost if I didn’t build a single house?” If the answer is no, then very likely it should be included in your COGS category of your P&L.
When you apply the formula: Sales - COGS = Gross Profit you have a beautiful number that gives you insight into your business. GP basically tells you you have x amount left over for further investments into the business after paying all the costs associated with building houses, to use our example. When you’ve properly determined this amount, you can boldly make decisions regarding overhead, advertising, office personnel, rent & interest, to name a few.
It goes without saying that by analyzing COGS and keeping material & labor cost to a minimum you will make more informed decisions and move your business forward!
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