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Nov 23Steve Janson

Understanding where you make your money?

Nov 23Steve Janson

Traditional accounting systems are designed to report the overall financial performance of your business.  Good financial controls and procedures are essential to provide you with meaningful monthly financial statements.  Timely, accurate reporting of your monthly results are a key management tool for assisting with tactical short-term business decisions, as well as charting your progressive and accumulating data to support your long-term strategic goals.  Traditional accounting systems do a good job of reporting the overall progress of your business, but you really need to dive deeper into the numbers when you ask yourself, “Where do I make my money?”

  1. Redefine your Product / Production Costs – Traditional GAAP procedures provide rules and guidelines to determine your cost of sales, but is it a true reflection of your cost to produce each product?  If you purchase components for assembly, or buy products for resale, it’s fairly straightforward to include the historical purchase price in your product cost, but the cost to produce your product gets a little more complicated.  All costs related to your production should be broken down between variable and fixed costs.   Your variable costs should be directly connected to your product; for example, assembly labor or direct supplies.  Your fixed costs should be allocated based an accurate reflection of their value to your product.   Products that require more floor space, sophisticated machines, or supervisor attention should be charged an appropriate share of these costs.  As your processes and procedures change, your method to allocate fixed costs should be updated.
  2. Analyze Product and Product Line Margin – Once you have accurately assessed your production costs by product, you can utilize this information to determine gross margins by product and product line.  By understanding your product profitability, you can evaluate your sales strategies to focus on selling the products with the highest margin.
  3. Create Gross Margin by Customer or Channel Reporting – This level of reporting is fairly simple, once you’ve developed good product margin reporting.   By analyzing your gross margins by Customer or Channel, you can adjust your strategic plans to focus on opportunities in the marketplace.
  4. Assess your Sales Support and Administrative Efforts – This step is often missed but it is essential to understand your true overall costs.  Certain customers or sales channels have higher support costs including field sales force attention, customer service, and potential uncollectable receivables.  These costs should be appropriately allocated to the customer or product to get a good understanding of where you make your money.

A good understanding of where you make your money is essential to drive your business in the right direction.  As with any costing systems, it is important to maintain your assumptions and allocations as your processes change.  A good review of your overhead costs should be complemented by a proactive process for continuous improvement of all your purchased components, products, and supply costs.  With the right reporting systems and accurate assumptions, you’ll have a clear understanding of where you make your money.

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