Understanding Direct And General Expenses | Virtual CFO
Understanding the difference between general and overhead expenses can help entrepreneurs calculate gross margin in their business says virtual CFO. The reason why this is important is when an entrepreneur understands how much money they are making in their business, they can ensure that there avoiding running out of money. Since running out of money is the second most common reason why entrepreneurs in Canada fail, learning how to calculate their gross margin early on in their entrepreneurship can help entrepreneurs avoid this problem, and succeed in their business.
The direct expenses in a business are often also called the cost of goods sold and are all of the costs that are associated with producing the product or service that the business sells. These are all of the expenses that an entrepreneur will have if they have sales in their business. If they have no sales, they will not have any cost of goods sold expenses. As the sales of the business go up, so will the direct costs. Examples include raw materials and labor. For example, a contractor would have all of the materials that they would use on the job site, as well as all of their laborers. A medical practice, on the other hand, would have the associate doctors, hygienists or lab costs.
In general expenses or overhead expenses as they often called says virtual CFO all of the costs to the business regardless of what they have sold in a month. These costs typically do not fluctuate very much from month-to-month. examples of general costs include rent, utility bills, administrative staff, office supplies, phones and the Internet to name just a few.
In order for an entrepreneur to calculate the gross margin in their business, you need to understand both these costs, and not lump them together. By taking the monthly revenue of the business, and subtracting the direct costs, an entrepreneur ends up with the gross margin. If they were to subtract all of the expenses, they would not end up with the correct figure, which is why it is important to understand the difference between direct costs and general costs.
Landing up with the gross margin, an entrepreneur can calculate how much money they have made in their business, and that is how they pay for their overhead expenses. You need to ensure that their pricing their products or services at such a rate that they can end up with a gross margin, by figuring out how many products or services they need to sell in order to cover that overhead expense is the entrepreneurs breakeven point.
By being able to calculate the breakeven point early on in their entrepreneurship, can help business owners understand but their sales need to be at in order to cover all of their expenses. By learning this, business owners can figure out but sales they need to have in order to avoid running out of money in their business. By having this goal in mind, can help entrepreneurs achieve that. If business owners do not have this figured out, they may not understand that there running out of money in their business until it is too late.
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Learning how to understand business financials early on in their entrepreneurship is extremely important says virtual CFO. The company that makes accounting software QuickBooks did a survey of small business owners in order to gain an understanding of how financially literate they were in their business. Respondents of the survey were asked questions about income statements, balance sheets, and how to improve cash flow. A large majority of all respondents, 82% scored less than 70% on this test. This shows that many entrepreneurs struggle with understanding business finances, which can contribute to them making poor financial decisions in their business.
One of the most important things that an entrepreneur can do is understand how to read their financial statements and primarily their income statement. Many entrepreneurs use their balance sheet in order to make financial decisions, virtual CFO recommends that entrepreneurs use the income statement instead. By using this, helps entrepreneurs understand the profit and loss, gross margin and overhead in their business. In addition, learning how to read the income statement can help entrepreneurs make well informed financial decisions in their business.
In order to ensure that their income statement is easy to read, business owners should ensure that they have three revenue accounts or less. Not only does having three or less ensure that income statement can fit on a single page, in order for it to be easy to read, but also has three income statements or less can ensure that an entrepreneur does not have their revenue misclassified, or spend a lot of time trying to classify revenue.
For example, doctors should separate their own revenue from their associates’ revenue, so that the doctor knows how efficient they are and how efficient their team is. A contractor, on the other hand, will also have to, but one for projects and one for service calls, because there is huge differences in the time, management, and supplies used in both types of business. A restaurant would have one because they sell food. May be to if they have a catering business, or if they sell merchandise as well says virtual CFO.
It is also very important that entrepreneurs avoid putting in income that is not related to their core business in the revenue section. While it is important to account for this revenue, they should put it in a different category called other income and expenses for things like money made from rental income, dividends from a stock portfolio, or gains on any investments they have made. However, if entrepreneurs put in the revenue section of their business, it can actually impede the ability to appropriately calculate the margin in their business.
By understanding early on in their business how to read their income statement, and calculate the revenue in their business can help entrepreneurs ensure that they have the right information to figure out how much money they are making in their business, and how to use that information to make informed financial decisions with.