Like any profession, accounting has what seems to be impenetrable jargon to outsiders. But, also like most professions, the jargon is just shorthand for the most-used and usually most important terms when accountants talk about the businesses they are either managing or evaluating.
Here’s your mini-CFO guide to the 15 most important – and also useful – terms that small business owners need to understand so they can have meaningful conversations with their accountant and manage their business better.
MARGIN AND PRICES
1. COGS: cost of goods sold
You can’t run a profitable business unless you make a margin between what it costs to source the product and what you receive from selling your goods and services to customers.
A businesses cost of goods sold includes the cost of purchasing the good from the supplier as well as any additional costs that accrues to the from its supplier plus any additional costs that are incurred getting the product into inventory and ready for sale to customers.
Cost of goods sold does not include selling and administration expenses, administrative expenses or financing expenses. All of these additional factors impact overall business profitability but they are included later on your income statement.
2. Gross Profit Margin
Now that you know how much your cost of goods were, and when you have a solid read on how much revenue your sales generated, then you are ready to calculate your gross profit margin.
This is just the first step in working out overall profitability of your business as it is simply the difference between the selling price of a good or service and the revenue received.
Your margin is then calculated as a gross margin percentage which shows the proportion of profit for each sales dollar. The higher, the better.
3. Operating Profit Margin
The gross profit margin doesn’t tell you what it costs to operate your business. It doesn’t take into account the “other” fixed and variable costs of generating sales revenue.
Operating expenses are those incurred as a result of normal business operations, (wages, R&D and so on) and together with the cost of goods sold these are subtracted from sales revenue to give an “operating income” figure.
Operating Income (profit) is then divided by sales revenue to give an operating margin. Once again the higher the margin the better.
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