The advertising world pommels us with messages about great deals on our favorite things. From a consumer’s point of view, the more reductions, the better—even though the offers can be more alluring than the actual savings turn out to be. For the small business owner, however, there is a type of reduction that is much less fun to ponder. It’s the amount of revenue that will be reduced by their business costs, which include operating expenses and Cost of Goods/Services Sold, or COGS.
One of the chief misleading numbers for business owners is Gross Revenue. While the check we just deposited for $20,000 makes us feel pretty good, before we spend any of it, let’s be sure we’ve covered all the costs it took to make that cool 20K. Unfortunately, I’ve seen too many entrepreneurs who are growing quickly let their excitement cloud their ability to monitor related costs. Losing sight of what it takes to make that revenue can ultimately lead to overspending, late vendor payments, and worse.
To consider COGS—as opposed to Overhead (OH) costs—be sure to look only at the costs directly related to producing that good or service. As an example, suppose a marketing firm is producing a client’s campaign. They need to consider the cost for the freelance graphic artist who produced the artwork. But they don’t need to consider the payroll cost for the firm’s admin assistant, since that’s an OH expense. As the firm matures and its operations become more sophisticated, more of the overhead costs should be amortized over the various projects during a fiscal period. At that point, Gross Margin by Project may be calculated, which is a great benchmark for firms trying to assess the profitability of their products or services.
Bottom line: Don’t be seduced into spending money that hasn’t been fully accounted for. Make sure you understand your costs and how much of your revenue is profit. Then spend that profit wisely, like a smart consumer would.
Virginia McGann is the founder and CEO of Value Management Resources in Chicago, IL. She specializes in coaching start-up firms into growth; struggling firms to stronger footing; and high performance organizations to ever greater results. You can reach her at firstname.lastname@example.org.