Month: September 2024

I’ve got to share a dirty little secret with you. Every company I have ever worked with has miscalculated their prices and profits because they underestimated their Cost of Goods (COGS), ignored the Cost of Sales (COS), or did not understand other Variable Costs. These miscalculations are more common than you think and can seriously affect your bottom line.

What is a Variable Cost

COGS refers to the direct costs of producing goods, including materials, labor, and manufacturing overhead. Even in a service business, a COGS expense will always vary directly with production volume. The broader term of “Variable Costs” might be a better way to think of this: anything that changes with the output level is a variable cost, and might be considered COGS.  Besides materials and labor, this would include shipping, sales commissions, and customer acquisition costs.

Sometimes it makes sense to capture sales commissions and other selling costs under their own category called Cost of Sales, or COS. If this distinction is meaningful to you, then your financial statements can have both a COGS and a COS section so you can see which expense categories are dragging down profits.

No matter how you format it, failing to account for all of your variable costs correctly can lead to product underpricing, where the selling price does not cover the total cost of production and sales.

First, Don’t Fail

Profitability analysis is crucial, especially when launching new products. Recent studies show that 42% of startups fail because they miscalculate market demand and pricing. Businesses that conduct thorough profitability assessments are more likely to succeed long-term. Without a clear understanding of your variable expenses (COGS + COS) you risk underpricing your products… which of course is the first step toward failure.

The Art and Science of Pricing

Profitable pricing starts with market research to understand demand and how much customers will pay. Knowing what competitors charge — and how your products or services are different —  helps set realistic pricing that covers your costs.

Market insight is sometimes more art than science, but accounting can add a strong foundation to your pricing strategy.  To set a profitable price, you must know ALL your costs, including production, shipping, sales commissions, and customer acquisition costs. The price you charge, of course, must be greater than all these expenses — with enough left over to cover overhead AND profit!  But I’m getting ahead of myself…

Next, perform a break-even analysis to determine how many units your company must sell to cover its “Fixed” or “Overhead” costs. This analysis shows the top line sales (in dollars) required to start generating a profit. The formula is simple:  

• Overhead / Gross Margin Percentage = Sale Break Even.

Can your company achieve that basic “Break Even” sales number?  How much more can you sell without expanding the overhead?  Understanding the relationship between overhead costs and the sales needed to support overhead is a critical lesson for every entrepreneur. 

Now go further by using a simple spreadsheet to see what happens to profit if you change your pricing. Perhaps you can even predict future revenues, expenses, and profits and plan for various scenarios, ensuring your business remains profitable even when conditions change. 

Finally, close the loop by reviewing how your price stands up to competitors. Can you undercut the competition and be the low-cost leader?  Or are you priced as a premium in the market?  Knowing this drives every other business decision you will make!

Prices Drive Profits

Good pricing is good business. Determining the right price for your product or service requires market research, a break-even analysis, and knowing every variable cost. Use these 3 C’s (COGS, COS and COMPETITION) to make profitable decisions about pricing.

If you’re unsure whether your products are priced correctly or whether you’re covering all of your needs, we can help. Schedule a free business analysis with us, and we’ll dig deeper into your business to ensure every product you sell contributes to its profitability.

You know it’s true — standard financial reports suck. They are hard to read and rarely give a business owner helpful information.  But you can build meaningful reports that power your business forward. Even balance sheets and income statements do NOT have to be produced in a standard, boring format.  Instead, learn the art of making your financial statements tell you what you need to know.  

Why change your reporting format?  Because when you can easily and intuitively read your financial results, you will make better business decisions.  And if you’re not even reading the standard reports, what’s the point?

Making financial statements that speak to you and give you the data you need is not hard. Here’s a few practical strategies to help you master the art of creating tailored and meaningful financial reports that help your business thrive.

You’re Not Alone

If you struggle with financial reporting, you’re not alone. Many business owners consider keeping accurate financial records a significant challenge and most have no meaningful way to use financial statements to make decisions.

But entrepreneurs (and CFOs!) who can extract meaningful information from boring accounting data will be better able to avoid financial pitfalls and achieve sustainable growth.

Start Over: Build Reports That are Meaningful to YOU!

Forget the plain vanilla reports that you get from QuickBooks or Xero.  Right out of the box, these reports are likely to be long, hard to read, and frankly not very useful.  Without further analysis, most financial statements are useless as management tools.

So. How can you get creative and build reports that actually answer your burning questions about your business?  Here’s some simple steps:

RE-Categorize. All income and expenses in a business have to be categorized (into what we call the Chart of Accounts), but you do not have to use the standard categories. Instead, think of your Chart of Accounts as a blank canvas. 

With the help of an accountant or QuickBooks expert, describe the big categories that are most important to you, and make your Chart of Accounts mirror what’s actually important.

For example… Instead of “Office Supplies” with ten subcategories for “Pens” and “Paperclips”, how about a larger category called “Occupancy Expense” that includes rent, utilities, supplies and insurance?  Rarely is success dependent on how much you spend on paper clips, but big decisions can be made by understanding everything that you’re spending on your office or store-front.

• RE-Focus: Fewer accounts are usually more helpful than too many (fewer accounts make expenses easy to understand and more meaningful). Do you really need 3 categories for Travel?  Or are travel expenses really part of Marketing?  Do you need to measure each different kind of item you use in your processes, or can you have a large “Supplies” expense that captures smaller purchases?  Decide upon the big “meaningful” categories that you can monitor and control.  Those will be your starting points.
• RE-Think:  One of the most important things about expenses is whether they are “Variable” or “Fixed”.  If you spend even 10 cents on, say, glue that you use to make a product, or if you drive 10 miles to deliver your services, those expenses should  be captured as “Variable” expenses — also called “Cost of Goods Sold” or COGS.  Re-think every expense and decide which ones are actually part of the product or service that you deliver. Make sure they are captured in your “COGS” section of the Income Statement.
• RE-Format:  This is the fun part.  The work you’ve done above will improve any financial statement, but now you get to re-organize and re-format the reports that YOU want to see.  Need to see the sales from every red widget compared to your rent expense?  You can do that!  Want to know how many blue widgets were produced compared to your total wages paid?  That’s great!
• RE-Move:  Reformatting financial reports can be done inside some packages.  But if you want to get creative and powerful, consider removing your reporting from QuickBooks, and instead use a package like Finatical Software’s Flash Reports.  This is my new favorite, and a very powerful tool to create meaningful reports in Excel simply, quickly and with instant updates.
• RE-view Regularly! Remember, the best reports in the world are meaningless if you don’t review them regularly.  Start by reviewing your new reports weekly.  You may find that you need to tweak them early on, but pretty soon you’ll be able to track trends and see how each decision you make in the business impacts and changes the results you see in your report.  THAT’s when running your business starts to get fun!

FuseCFO Will Be Your Mentor For Financial Reporting

Great financial reporting is not just for accountants, it must drive decisions by the business owners and managers.  Get the insights needed to drive your business forward. By re-working your financial reports, building dashboards, and knowing the numbers that impact your business, you can ensure that your reports are both precise and meaningful.

At Fuse CFO, we can help you implement these strategies effectively. Schedule a free business analysis with us, and let’s work together to ensure your financial reports are a powerful tool for your business success.