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Chapter 15: The Bottom Line - Page 15.2

Costs, COGS, Direct Costs, Gross Margin

Although we discussed cost of sales or COGS in Forecasting: Forecast Your Sales, you should know that it is important to Gross Margin. In standard accounting, the cost of sales or cost of goods sold are subtracted from sales to calculate gross margin. These costs are distinguished from operating expenses. Gross margin is also called Gross Profit.

The division between costs and expenses doesn't change profits. Some very simple bookkeeping systems ignore the distinction altogether. Whether you call it a direct cost or operating expenses, the amount still reduces income. A few service businesses have either tiny direct costs or even no specific costs of sales, which creates a Gross Margin of 100%. For example, a business consultant, attorney, or tax accountant might easily have no specific cost of sales for an engagement, because the deliverable is expertise. Even in these cases, however, there probably is a small cost of sales, such as photocopying expenses or paper or burned CDs. Because computers have difficulty with dividing by zero, you might be better off to estimate Gross Margin at 99% instead of 100%.

A good calculation of Gross Margin depends on properly dividing costs and expenses, and a good calculation of Gross Margin will help you compare your business to others like it. Industry databases including the ones included with Business Plan Pro® track gross margin by type of business. This is always useful to provide at least a rough idea of what things generally cost, and how much things are marked up. For example, retail sporting goods stores make a Gross Margin around 33%, which means that what they buy for about $100 they sell for about $150.

Timing of costs is very important. A bookstore's costs for a book it sells goes into accounting as COGS when the book is sold, not when the bookstore buys it. For example, if a book purchased in October sells in March, the COGS applies to March sales. Remember that you can't calculate the correct Gross Margin unless you correctly apply the direct costs for what you sold in a given period without regard to timing of acquisition or payment.

Unit projections can help calculate both sales and costs.


Copyright © Timothy J. Berry, 2006. All rights reserved.