It’s an occupational hazard. I meet with a client or connect with them over the phone to talk about their business finances, and as I’m delving into their numbers, terms just fly out of my mouth.
Accrual. P and L. Trial balance. General Ledger.
Bookkeepers like me feel like I’m speaking in plain English, but I soon realize by my client’s silence or dead stare that they’re trying to keep up, save face and avoid embarrassment by asking what I mean. I understand, and I hope this “Glossary Glance” series saves you the awkwardness of stopping me to ask what on earth I’m saying.
So, let’s start by tackling these terms, two by two. It’s easier to digest, and frankly it’s really important for you to really comprehend because after all, it’s your business. Even though you’ve hired a professional to tend to your books, you still need to know enough to ask good questions and follow what’s going on. After all, you shouldn’t be a spectator when it comes to the management of your business’ finances.
To double down on this point, I encourage anyone who has heard a term or concept that they just can’t get a handle on, to let me know, and we will add it to this blog series. Don’t be shy – the only dumb question is the one you don’t ask!
I think it’s safe to say we know that profit refers to the money a business makes after it has paid its expenses or money going out (more specifically called net profit). Profit margin gives this term a little more perspective and breadth. It is usually expressed as a percentage, and generally the higher the percentage, the happier you are as a business owner. In the examples to follow, we’re calculating gross profit margin, or just the cost of a product versus the income received for its sale.
Let’s say you make customizable T-shirts. You charge $10 each for quantities up to 11, and $9 for orders by the dozen. That’s your income portion of this equation.
(Math alert!! Please stay with me. It’s not too tough from here.)
Your T-shirt supplier (you after all just design and place the ink on the shirts) charges $4 per shirt, and $2.50 for quantities above a dozen.
Customer A purchases 10 shirts. You get $100. You pay your supplier $40, which leaves you $60. Obviously there may be other costs to produce the shirts, but for simplicity’s sake, we’ll leave it at that.
Your profit margin is 60 percent, or $60 kept out of every $100 in purchases.
Customer B orders 100 shirts, pays you $900, and you in turn pay your supplier $250. That’s a profit of $650, and a profit margin of slightly more than 72 percent.
Overall, it’s a simple concept, but we’ve also left out of this equation other costs that can erode your profit margin. In these examples the cost of labor to create, process and package these shirts, which is included in operating profit margin, hasn’t been figured in. Unfortunately there’s no volume discount on wages, and if the production of 100 shirts means additional employees throughout the process, it may not be as sweet of a deal.
We also haven’t calculated other taxes, interest on business loans and other obligations, all of which are a part of net profit margin.
What a great bookkeeper will do is organize ALL of your expenses to compare against your income in order to determine your profit margins for products as well as services (with your time weighed against the income in these cases). A fantastic bookkeeper will then also help point out where costs could be improved or curtailed to raise your profit margin.
If you want to think in literal terms, this refers to a business’ cost just to be open – and in a bricks and mortar sense – ‘what’s over your head.’ The rent, electricity, property taxes, etc. that are a part of the standard business model is part of overhead costs. None of these costs directly serve to put a product on the shelf, or a marketing campaign in your client’s hands, but are all too real to ignore.
But what if it’s just you and your laptop, a smart phone and your usual corner table at the local coffee shop?
Overhead still applies, especially if you could get evicted if you don’t buy a $7 latte every day. For solopreneurs like you, there are still costs like business insurance, fees paid to hire professionals like attorneys and (ahem) bookkeepers, advertising costs, merchant processing fees, or any licensing or government fees to run your business.
Of course you need a great bookkeeper, and ironically it’s to help identify what your overhead costs are and track them. As you’re going about the business of your business, then, a bookkeeper is likely looking at these expenses to see where there can be efficiencies, saving you money and perhaps helping you work smarter. And speaking of you working smarter, if you were the person working late into the night trying to balance your books, outsourcing a bookkeeper also takes that time expense off of your plate.
A good pairing
It really wasn’t random to put profit margin and overhead together, by the way. As I mentioned earlier, it can be easy to focus on formula when considering your profits. Profit margins should include the cost of overhead (operating or net profit margins) for the best snapshot of how well your business is operating.
OK, that’s enough for today. Suffice it to say that to get to a better profit margin, much of the focus can be directed at the overhead, reducing or eliminating costs that only indirectly help you make money. An experienced bookkeeper whose focus is tracking your expenses can keep overhead low, while keeping your profit margins up.