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E-Myth – “Why most small businesses don’t work & what to do about it”

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Virtual CFO | Revenue And Direct Cost Of Sales

One of the biggest challenges that entrepreneurs often have as they start their new business says virtual CFO, is that 82% of entrepreneurs have failed financial literacy test given to them by into it, the makers of QuickBooks. Because so many entrepreneurs lack basic business financial literacy, they struggle at understanding their financial statements, which causes them to not understand profit and loss, gross margin and overhead, which can impact their ability to turn a profit in their business.

Some of the first things that entrepreneurs should understand when it comes to understanding their income statement, is how many revenues accounts most businesses should have. Virtual CFO recommends that all entrepreneurs have no more than three, and potentially even less. The reason why is because having many revenue accounts not only can create a lot of work and increase the potential for miss classifying expenses. But also, the more revenue accounts there are, means the harder it is for the income statement to fit on one page. It is very important that the income statement fits on one page so that an entrepreneur can use that to make good and large business decisions.

Virtual CFO says that some examples of revenue accounts for various businesses could be: a contractor that has two accounts, one for projects and one for service calls. A restaurant might have one account for food and that is it. Perhaps, they might have a second revenue account if they sell any merchandise out of their store. I dentist, for example, might have three accounts one for the doctors income, one for the associate doctor’s income, and one for the hygienist. As a general rule, entrepreneurs should keep in mind that less is best.

Something else that entrepreneurs should keep in mind, is that they should avoid having an income that is not related to their core business in their revenue section. It should always be kept separated says virtual CFO. Loan entrepreneurs might have profit from things like rental income from a property that they own, dividends from their stock portfolio, but if they keep all of these extraneous streams of revenue in the revenue section, it could interfere with an entrepreneurís ability to appropriately calculate the margin of their business. However, they still should exist on their income statement, but just in another category called of their income and expenses. By keeping these separate, an entrepreneur can ensure that there including the necessary income that they are bringing in, but in a way that is not going to inflate the direct revenue of their business.

When entrepreneurs start to understand how to calculate the revenue and expenses in their business, they will gain the ability to more appropriately calculate the margin, so that they can ensure that they are making money in their business, covering not only the cost of goods sold, but also covering the overhead expenses in their business. By doing this, entrepreneurs can ensure that they are making enough money in their business to cover their expenses.

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Many entrepreneurs get into owning their own business, because they are good and passionate about the products or services that their company sells or produces says virtual CFO. However, just because they are passionate about their business, does not mean that they have all of the skills to actually run that business effectively. As a result, many entrepreneurs struggle with understanding their income statements, profit and loss, gross margin and overhead. By misunderstanding all of this information, it impedes their ability to turn a profit in their business. If more entrepreneurs could understand their financial statements better, it could increase their ability to succeed in business.

When understanding the revenue and cost of goods sold in their businesses, entrepreneurs should understand that direct costs fluctuate while overhead expenses do not. Virtual CFO says the reason why is because once an entrepreneur has their overhead expenses of the business, they typically stay the same, or very close to it every month. The rent, utility bills, the phone and Internet, the office supplies and administrative staff are all going to stay is essentially the same. It is the direct costs that fluctuate. The reason why, is because the more sales a business has, the more their expenses go up. For example, if it costs them five thousand dollars to produce ten thousand dollars worth of revenue if they sell twenty thousand dollars, there direct costs are going to go up. The biggest thing that entrepreneurs need to keep an eye out for, is that the direct costs should fluctuate by the same degree as the sales. The sales go up 20% the direct costs should go up 20%, if the sales go down by 20%, the direct costs should do the same thing.

Another thing that entrepreneurs need to keep in mind says virtual CFO, is that gross margin is when an entrepreneur takes the revenue in their business and subtracts the direct costs they end up with the gross margin. The reason why this is important to keep in mind, is because when direct costs go up or down, it indicates the sales of the business, however gross margin refers to the amount of money that an entrepreneur makes. It is important to know how much money an entrepreneur is profiting in their business. Understanding direct costs is great, but an entrepreneur needs to be profiting in their business.

The reason why it is important for entrepreneurs to understand gross margin as well as cost of goods sold, is so that they can calculate their breakeven points. Since the overhead is not going to change, the entrepreneur needs to know how much they need to make in sales, minus the cost of goods. The amount left over in order to pay the overhead needs to be made every single month in order for the entrepreneur to pay all the necessary expenses. When they understand that, they know how many sales they need to make in a month in order to cover all of their expenses of the business. When they understand that, they can ensure that they are going to significantly avoid not making enough money to cover all of their expenses, and risk going out of business because they have run out of money.