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Hi,
thanks for joining us for another episode of ask [inaudible] CPA. Today we are talking about revenue and direct costs of good sold. I have call here with me again, call enjoying the nice weather, nice change our reef lipsticks or are we past every past winter? I’m not going to say you’re not going to say. Okay, that’s good cause I’d fire you. So, um, so the, the court that we have here today is a, you know, Warren Buffett all time great investor accounting is the language of business. You know, the statistic that I’ll bring up on revenue and direct costs of goods sold is intuit the makers of quickbooks. They did a survey of business owners and they found that 83% of the business owners go to score of less than 70% on basic financial literacy literacy test. Um, so understanding their cash cashflow, their profit and loss, their balance sheet.
Um, you know, the story that we have, is it business owners, they’re not entirely sure what belongs in the revenue and direct costs of good sold, how many accounts that they should have, you know, uh, in this interferes with their ability to really understand their gross margins of the business. Um, in what sort of, you know, overhead that they can sustain. Um, if they can’t understand what the gross margin of that business is, it’s a cold. What are the questions you think these business owners should be asking? How many revenue accounts should most businesses? I would say most businesses, most businesses should have three or less revenue of cats. Now give you an example. You could have a restaurant and that restaurant might have and revenue account for every item on the menu. Edmonton Bookkeeping is how you will stay on top. Um, you’ll, you’re just creating a lot of work, um, and you’ll start getting, you know, misclassifications the more revenue accounts, more counts you have in general, the more classifications that you’re going to have.
And at the end of the day, what is that really telling you? We still have items. Remember you can still do reports on items, but the idea is from an account is we should be able to put all of our, uh, income and expense accounts on one page and make good decisions from it. Not have it on eight pages. So most businesses is three. You go to a restaurant and it’s one, you know, what are the, the food sales. Maybe if you sell a product to sell t shirts or something of the restaurant, maybe that’s the second one. Your average contractor, they might have one account for projects and other account for service calls. You know, maybe you’re a dentist, for example, you’ve got an account for what the, uh, owner brings in and billings, what the associate doctor brings in the buildings with the hygienist bringing in billings. There’s your three or there could be some circumstances where she had more, but I would suggest that he probably needs less. Um, so yeah, I would say three or less.
Okay.
Should doctors normally separate owner revenue and associated revenue? Yeah, that, that, that’s the big one. You know, we talked about, you know, having less accounts, but there are some times where you want that uh, separated. And if you’re a physician, you have associate doctors working in the clinic, you do want to know how much your billings are as opposed to what the buildings of the associates are. Uh, it’s going to be a real telling fact on, you know what, there’s a lot of revenues. Is it because, is it because that the owner physician is just being super productive and working a ton of hours or was it because of the rest of the associate team is carrying some of the load as well? That’s one thing that I would break up for sure. Would trades normally separate projects and service work, that’s usually the natural, uh, delineation. Uh, usually the AE, oh, you’re out beating on larger projects and that can go up and down and then the service work has kind of trickling in.
Um, so you do, you don’t want to understand what the, uh, what the differences are between those two items. It’s normally a natural part of it because you’re, you’re acquiring an APP business usually in, in different ways. Should you have income not related to core business and the revenue section? No. You want to make sure that we’re not putting, you know, things that belong in those other income and expense section. So remember, we’re going to have revenue, we’re going to have cost to sales. So we’re going to have eight. They were going to have our gross margin that we’re gonna have our overhead expenses and the income from operations and we still have this other income and expense section. So things like the, the rental income that you’re making off the Condo, they, the dividends that you’re getting from the stock portfolio that gain on any big, you know, uh, investments or equipment, you know, we don’t need that in the revenue section because that’s not dealing with the core businesses.
It’s really going to interfere with our ability or so could interfere with our ability to calculate the margin correctly because we’re often having to back stuff out of, of what happens. So, um, you know, those, those items is like they belong in the other income section. Why do direct costs normally fluctuate more than general overhead expenses? Yeah. So, you know, usually you’re looking at your overhead expenses and you’re saying, I want to control these. I want to keep these in a certain level. But when it comes to your direct costs, if they go up, that’s not necessarily a bad thing. So let’s say you know, you’re a contractor and you make, you know, 33% on every job you can make a third of a, of every job roughly. Um, you know, if, if you did more work that month, you would expect you had to pay more sub trades and buy more materials and, and so, you know, the, um, they’re going to fluctuate more. Stay proactive with Edmonton Bookkeeping.
So usually your direct costs directly fluctuate at, uh, you know, hopefully it predictable margin. Edmonton Bookkeeping is a great way to get ahead. Um, depending on how much work that you do, our trades normally going to break down Labor’s subcontract and materials. Yeah. Those are usually the ones that you want to break down so you don’t move her hand labor. We’re looking at subcontract and we’re looking at materials and sometimes the labor and subcontract, they can be very similar in some might argue why they’re broken down. I would say it’s, you know, for some internal analysis, either some, you know, real different tax treatments on how we handle, um, you know, employees of a company versus subcontractors of a company. But also, you know, knowing what that, that Labor forces is deployed you, theirs is really useful. And same with the materials and there’s different tax treatments for material contracts than there are for contracts that um, you know, have, you know, a labor component to them.
So I think those are the three that most, uh, construction trades and want to be breaking down their cost of good, sold into his, you know, labor, uh, subcontracts and materials. And they might end up in around about way having a six because if they have project and service work, they would have those three components that deal with each. So it would be labor on projects, subcontracts and projects, materials on projects and then Labor on service and subcontracts on service and, and, um, materials on service. What are some of the common costs of goods sold? Accounts for medical practices? Most medical practices is the associate physicians. So usually you’re going to start with the uh, associate physicians there. If you have an associate doctor, most clinics or are paying them a percentage of their billings, so of that associate billed $20,000 in the month, you know, they might get 70% of those buildings and, and they get $14,000.
Um, so you know, most of the time it’s going to be the associate physician. Number one. Uh, we run into things like, uh, uh, dental practices and dental practices. They might delineate then, uh, how much they’re paying the hygienists, which is a different revenue stream and they can make different decisions based on that revenue stream as well as dentist. And generally it’s the lab costs. Often they’ll have big lab expensive that are more like a flow through expense. You know, similar to a construction guy, bunch of buying a bunch of materials. So you bought nice and materials on this job. You know, the Labor might not be that more dental practice is very much the same way. So lab expenses tend to be a direct cost to sales that you want to, you know, pull out of the, the general, um, medical supplies, the gauze and band aids and that sort of thing.
You want to journal medical supplies with the lab costs. If you’re a dentist, you’re going to be putting those lab costs in a, in a specific count. We deal with some optometrists and again, they have the associate doctors, but they’ll also want the cost of the glasses and contacts to a, that’s going to come out of um, um, an optometry practice. What is the risk of having too many accounts? So the risk having too many accounts is, you know, I, I can’t get this on one page. Number one, I can’t get this on one page. So I’m looking at my profit and loss statement and I don’t have one page where I can go to and make big decisions. Can I buy this equipment? Can I hire more staff? Do we have to lay this staff off? Do I have to change my pricing? I want to be able to look at one piece of paper and make that decision.
Um, so the other issue, even if you know, if you had the ability to interpret the multiple pages, which I think there’s too much room for error, um, you know, there’s a reason why big huge publicly traded companies have, they still have a one page income statement somewhere in that a big package so that they get from the auditor. Edmonton Bookkeeping is going to have a huge impact. Um, I think it’s, uh, when you have those too many accounts that you also have these classification and our risk. So one month you declared office supplies, the next month you’d declare it, printer ink will come on. How much printer ink are you buying every year? And you don’t need an account for that. And even if you, you tracked it, you know, even if you did have that account, you always have that risk where you classified it as one thing, you know, one year or one month and the next thing the next year, the next month.
So now when you’re trying to do some variance analysis from one period to the next, you might think that costs going up or the cost went down. It really the co no change happen. It was just classify it as something different. So the more accounts you have, the bigger the risks that you have with a classification air and the harder it is to interpret the entire big picture to make big picture decisions. What is gross margin and why is it more important than total direct costs? Yeah, so that gross margin is when we have the revenue and then when we have the direct costs. So if we take that revenue less a direct costs, we get the gross margin. So, uh, we have the contractor, and let’s say he, he makes 25% on the job. So he had $10,000 in revenue and it’s 75 or $7,500 in direct costs and there was $2,500 in gross margin.
So after he paid those direct costs, what was leftover from that a job? So that $7,500 expense, it’s not a big deal. If that goes up or down every month, what’s more important is what was the margin left over afterwards. So after we paid for the, you know, the labor and the supplies that and the subcontractors that directly related to that revenue stream, what’s leftover, what’s our margin is much more important than direct costs because direct costs going up could be a good thing. It just means we might have sold more that month or bigger revenues in that month. How does separating and understanding gross margin and help you clarify the braking? Yeah, so if you just group all these expenses together, you’re not going to be able to do a good break even analysis. And we get to that contractor, you know, he might have $10,000 in overhead expenses, you know, as a receptionist and as rent and they asked him office supplies and his insurance and all of those overhead expenses are $10,000 we have those separated from the direct costs and he’s making, you know, 25% on each job.
So he needs, in order to cover the $10,000 in overhead, he needs $10,000 in gross margin, not on sales. Don’t wait for something bad to happen in your business and be proactive with Edmonton Bookkeeping. So if you, if we separate the revenue and direct costs, we can figure out what that gross margin is. And in this case it would be for every, you know, $4 at 25%. There’s a dollar in gross margin. So if he has $10,000 in overhead expenses, if we have them separated, now we know, hey look, if you want to pay $10,000 in overhead expense, your breakeven is actually $40,000 a month in revenue. But if you have all those expenses and they’re all commingled together, you’re never going to get to that number. So it’s really important. You’ve got your revenue, you got your costs directly relate to that revenue stream, you get your gross margin, then you have your overhead, which for the most part, your overhead stays, you know, a lot more consistent than your, your, uh, direct expenses because the, you know, your overhead, you know, stays the same month, same rental space, same reception costs or whatever that is.
That doesn’t change that much. So, uh, having them separate makes it really easy to understand, but you know what your, your break even point is. So thanks very much for tuning in. It’s all the time we have today for this one. So as always, please hit the like unsubscribes, so we can continue to deliver you tips on how to beat the odds at business. And if you have any questions or if you have any requests for future topics, please leave them in the comments below and we’ll address them in a future video. Thanks very much. Thank you.
