Last week we went over the Revenue Plan and the Sales and Marketing Expenses. Once you have a first pass at this, you will need to put the rest of the plan in place.
Assuming you have done this on a spreadsheet, then this will be a matter of adding some rows. In the short term, all you need is the overall magnitude of the expense. In the long term, it will be better to format it correctly so let's follow that thread.
The first type of additional expense is called "Cost of Goods Sold" or COGS. If there are any costs that can be directly associated with a product sale then they need to be included here. Let's say that you were opening a Restaurant. The COGS would be the direct cost of making the food. You would certainly include the cost of the food, spices, and preparers. It is a little less clear if you would include energy costs or the cost to carry the food to the guests. The reality is that these other costs will be difficult to measure separately from the other ways
these resources are used. For example, can you separate the energy cost to cook food versus light the Restaurant? If not, then it is probably best to move these costs to a later category.
Once you have COGS, you can place this in a line directly below Revenue. If you subtract the two numbers, you will get Gross Margin (GM). This is the direct profit associated with making the product. This number is directly tied to Revenue and can be also put into a percentage. If you direct costs were 1/2 of the Revenue, then you can say you have 50% Gross Margin. This percentage is generally stable in a type of business and so you can then think of the business in those terms...."I get to spend about 50% of my total Revenue."
We already have Sales and Marketing Expense, as we did that work last week. We can place that information on the line below Gross Margin. In most businesses, the remainder will be "General and Administrative Expenses" or G&A. G&A includes costs like Rent, Accounting, Insurance, Licensing, Legal, and all the other expenses that a business might incur. If your business has a specific organization that has a lot of cost associated with it, you may be best off making that its own line item. The classic example of this is a High-Tech business. Those businesses will have a line item for "Research and Development" (R&D). This line or lines are placed below Sales and Marketing expense.
Now that this is done we can subtract the rest of the expenses from GM. This is now what is called "Net Margin" or EBITA (Earnings Before Interest, Taxes and Amortization). This is also called Operating Margin. This line represents the Profit from the business once all the expenses not related to financing the business are included. Again, this can be thought of as a percentage of Revenue. Analysts will say something like, "Net Margin is 5%". This means that 5% of Revenue ends up in profit.
Net Margin ends up being a great measure for how sustainable your business is. You need a reasonable profit to be able to put money back intot the business to keep going next year. On top of that if you have had to borrow money to run the business, then you will repay the debt with Net Margin dollars.
Now you are unlikely to be thrilled with your first pass numbers and we will talk about that next week!
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