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Virtual CFO | How An Entrepreneur Can Calculate Gross Margin
Learning how to calculate gross margin is extremely important to entrepreneurs says virtual CFO. The reason why is that entrepreneurs can understand how much money they need to make in their business to cover their overhead expenses. Since half of all entrepreneurs that business in Canada will fail, and 29% of those failed entrepreneurs say that the reason why their business failed was that they ran out of money. By learning early on in their business how to ensure that all of their expenses are covered, can help entrepreneurs significantly avoid the problem of running out of money.
In order to understand how to calculate what the gross margin in their business is, business owners need to understand the difference in general expenses and direct expenses. Virtual CFO says the direct expenses refer to all of the expenses that a business owner incurs directly as a result of selling their product or service. This includes the labour involved in creating that product or service, and all the materials that have gone into that product or service. An entrepreneur will not have these costs if they do not have any sales and will fluctuate along with sales.
On the other hand, the general expenses of the business are all of the expenses that will exist whether or not an entrepreneur makes any sales or not. Examples of these expenses are rent of the business basis, utility bills, phones and Internet, administrative staff, and office supplies. These costs typically will not fluctuate very much from month-to-month.
In order to calculate the gross margin of the business, an entrepreneur needs to take the monthly revenue of the business and subtract the direct costs in that month, and the entrepreneur ends up with their gross margin. Since the direct costs will go up or down depending on the sales of the business, the gross margin refers to the amount of money that is actually made. It is very important for an entrepreneur to know this figure in their business. Because understanding the gross margin can helps the entrepreneur understand what their breakeven point is. When an entrepreneur gets their gross margin, they need to cover all of their general expenses with that amount. Therefore, virtual CFO says that entrepreneurs need to be able to calculate how many products or services they need to sell every month in their business in order to cover all of their general expenses with their gross margin. By understanding what this figure is, can help entrepreneurs avoid running out of money in their business because they know how many products or services they have to sell in order to cover those costs.
An entrepreneur understands what their breakeven point is in their business can significantly help them avoid running out of money in their business because they know what they have to sell in order to breakeven. Virtual CFO says that this is extremely important for all entrepreneurs to do as early as they can of their business to help them avoid running out of money.
Virtual CFO | How An Entrepreneur Can Calculate Gross Margin
When entrepreneurs get into owning a business for the first time, they often lack basic financial literacy says virtual CFO. This can significantly and negatively impact the business, if they do not know what they have to make in order to avoid running out of money, or how to make informed financial decisions. One of the tools that entrepreneurs can learn to use right away in their business that can help them avoid running out of money is their income statement.
The reason why the income statement is so important is that it contains a significant amount of information about the business finances, in an easy-to-read format. This easy-to-read format means that an entrepreneur can easily utilize this statement before they make any financial decisions in their business big or small says virtual CFO. Whether it is deciding if they have enough money to run payroll or pay bills, or if they have enough money to buy an asset or hire new staff. By always consulting the income statement before making that decision can help entrepreneurs ensure that they have the money in their business to make those decisions, and if not, they can come up with a plan to bring that money in before making those purchases or payments.
In order for this income statement to be easy to read, the virtual CFO says that entrepreneurs need to ensure that they minimize the number of revenue accounts they have in their business. Many entrepreneurs believe that having several revenue accounts is important because they are able to get a lot of information this way, however, it actually ends up creating a lot more work, and increases the potential for miss classifications in their business. Having three revenue accounts or less means the income statement can actually fit on one page, in order to be easily read.
Another important aspect of the income statement is for entrepreneurs to avoid having an income that is not related to their core business and their revenue section. Things such as until income from a property that an entrepreneur owns, dividends from their stock portfolio, or gains on any investments that they have should be included in the on their income and expense category and not under their revenue section. The reason for this says virtual CFO, is so that an entrepreneur can ensure that the revenue section only contains revenue from the business, so when they calculate gross margin, it is as accurate as possible.
By learning how to read the year financial statements of the business including income statement as early on in their business as possible, virtual CFO says that entrepreneurs ensure that they are better equipped to make more informed financial decisions in their business. By doing this early on, entrepreneurs can ensure that they are avoiding making poor decisions early on in their business, that can help them succeed and grow.