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The first thing that an entrepreneur needs to understand is what the difference between direct expenses and general expenses are. Direct expenses are all of the expenses that are incurred by producing the product or service that an entrepreneur sells. This includes all of the raw materials as well as labour. These are all the expenses that exist in business as a direct result of generating sales. Overhead expenses, on the other hand, are all of the costs that a business owner has whether or not they generate any sales or not. This includes expenses like rent, utility bills, and office supplies.
In order for an entrepreneur to calculate gross margin says virtual CFO, is when the entrepreneur takes the revenue of the business and subtracts the direct costs. The resulting amount is the gross margin. Direct costs increasing or decreasing indicate what the sales of the business are month-to-month, however, the gross margin refers to the money that is made. It is very important to know the difference between direct costs and gross margin.
By understanding and separating gross margin can help the entrepreneur figure out what their breakeven is said virtual CFO. By understanding what the gross margin is, can help an entrepreneur figure out how many products or services they need to sell every month in their business to cover their overhead expenses. When entrepreneurs have that goal of how many products or services they need to sell in order to cover their overhead expenses, it can help an entrepreneur reach that goal, which will help them avoid running out of money in their business.
The next thing an entrepreneur should do is keep an eye on all of their expenses in order to ensure that the expenses are not out of control. The general expenses should not change very much month-to-month, and the direct costs should fluctuate the same amount as sales. If the direct costs are increasing higher than the percentage of sales, that is an indication to an entrepreneur that they need to minimize their expenses by looking for different suppliers, or different raw materials to use, or increasing their prices. By keeping their eye on this, they can ensure that they are covering all of their expenses to avoid running out of money.
Helping entrepreneurs understand what the gross margin in their business is can significantly help them avoid running out of money says virtual CFO. By having a goal to reach every month, of knowing what they need to sell in order to cover all their expenses can help an entrepreneur ensure that there doing everything in their power to reach that goal.
It is very important that entrepreneurs learn how to calculate their gross margin early on in their business says virtual CFO. The reason why, is because it can help entrepreneurs gain an understanding of their business financial literacy. In fact, into it, or the makers of accounting software QuickBooks did a financial literacy test of several small business owners and entrepreneurs in order to gain an understanding of how many business finances are understood by these business owners. Respondents of the survey were quizzed on things such as what a balance sheet is, what is accrual and how to increase the cash flow in their business. Out of all of the small business owners that responded, 82% of them score less than 70% on the test. This shows that many entrepreneurs, while very good at the product or service that their business sells, often lack the financial understanding that can negatively impact their business.
In order for an entrepreneur to understand their gross margin, they should be able to read to their financial statements and very importantly their income statement. By learning how to read their income statement says virtual CFO, can help entrepreneurs gain an understanding of their business finances that can help them make informed financial decisions. Before making any decisions financially, entrepreneurs should be reviewing their income statements to ensure that they have the money in their business to make that purchase payment. Whether it is paying bills, running payroll or large decisions like purchasing assets are hiring new staff, an entrepreneur should be consulting this income statement on a regular basis.
The power of the statement is that it can take a lot of complex information and put it into it easy to read one page that can help entrepreneurs make very good an informed decisions. However, in order for it to only be a single page, entrepreneurs need to ensure that they have three or fewer revenue accounts listed. Many entrepreneurs believe that they should have more because they have so many different revenue streams in their business, but most businesses need only three or less, including some of the largest businesses in the world. Not only does having more than three create a lot of work and can increase the potential for miss classifying revenue, but having more than three means the income statement will not be on a single page says virtual CFO.
By learning how to read their income statement, business owners can start to gain financial literacy, that can help them make informed financial decisions in their business. By consulting their income statement before making their financial decisions, entrepreneurs can ensure that the decisions they make are good, and informed and can help ensure that they are not going to put their business at risk of running out of money.
