While most business owners may not like to get in the weeds, sometimes it is important to dig in to the details to navigate forward intelligently. This becomes especially important for the inventory entrepreneur.
Margin analysis, in layman’s terms, is getting into the Profit and Loss (P&L) weeds to better understand the impact the small pieces have on the big picture — the overall operating profit. The intelligent business owner knows better than to just throw ideas and money at an idea and hope it sticks. This is a great way to waste resources and time. It takes forecasting and analysis to see where every decision along the way; from product development to final sale, impacts the bottom line. Let’s dive into the weeds for a bit, so you can better understand what items affect a company’s profit and what these five key lines in your P&L show.
What The Details Give You
So why do we get into the weeds instead of just getting the high level view? That’s what most executives want anyway, right? Well yes and no. It’s super important to establish and understand your key performance indicators (KPIs) and benchmarks starting at the micro level so you can make little, positive adjustments as needed. This is where you can spot less favorable trends before they become major disasters.
As far as the executive “high level” viewpoint being best, we beg to differ. If you are a company with investors involved, they are going to want to understand where their money is going and how you intend to grow their investment. The best way to forecast is to have an accurate understanding of your historical data — costs and sales. Being in the weeds helps provide this key data for forecasting intelligently. And when you have the little details in check, the high level is much more accurate, not just a BS version of things to get you by for another quarter.
Accountfully uses an amazing platform specifically designed to provide information in a clear, understandable format to monitor and view KPI’s, predict trends and report intelligently on complicated inventory based companies. It allows us to better understand the profitability of a company through different sales channels and see how things can pan out when making adjustments. All in a cool graph/chart type dashboard. We also leverage Quickbooks to help us pull reports and access data to understand and forecast intelligently.
The Five Key Sections to Consider in Your Analysis
Picture a funnel. We will start at the top of the lines on your P and L and work our way downward. As each line takes into account more expenses, it will filter out and condense the big picture into a more finite view of what a company really ends up with after each sale or your overall unit economics. At the top are the hefty general numbers: sales revenue. At the bottom is the overall operating profit — everything after all of the costs and expenses are accounted for. Within each of these lines, we can break out each by sales channel and customer to further see how each channel affects the profitability along the way. The easiest way to get a handle on each line, is to look at what each line considers as it filters down to the overall operating profit.
1. Gross Revenue
This is your top line revenue. This is that number that gets you excited when your Shopify App pings your phone with a sale. While it would be awesome to think that that amount of revenue is what you get to keep, that is not the case. Buzz Kill Alert: while it’s great you have cash coming in, don’t get too excited just yet. We still have a few more layers of analysis to work through.
2. Net Revenue
The next layer in the overall view of your operating profit is net revenue. This is your top line minus direct selling items like discounts or returned products. In accounting lingo, net means adjustments made to the original. In the online store example, this is seen when you run a promo and offer a discount code — all of those sales with the 15% taken off and the inevitable returns that happen will be accounted for here.
3. Gross Profit
This is the line where your all-important cost of goods sold (COGS) come into play. In the gross profit line, you will be taking your net revenue and comparing it against your COGS. This can get complicated on its own, so you will need to ensure you have a good handle on your COGS to have the most accurate numbers. For a refresher, you can revisit our Accounting for Inventory and COGS write up here. Remember that your COGS are all of the expenses related to getting your product ready to sell; raw materials, packaging, freight in, labor, etc. This line is where you start to understand your margins. Are your expenses considerably (or not so much) less than what you sell the product for? And by how much? If things are getting a bit ugly here, it is a big red flag, as far as margins and profitability go.
4. Contribution Margin
In this line you will see the costs associated with getting the product to the customer from the warehouse. Things like freight out, credit card processing fees, warehousing fees, pick and pack fees, etc. Here is where you can start to get a feel for whether or not you are overpaying when it comes to getting the product out. Are you paying too much for pick and pack services? How do these costs stack up next to your COGS — things like labor and the items prepping the product in the initial sale prep?
5. Overall Operating Profit
Now we are at the base of the lines — the “bottom line”. Here is where we add in more sales channel-specific costs and can get a better understanding of how each sales channel affects this overall line. When you break this out by sales channel, the biggest costs that come into play tend to be advertising and commissions. Here is where you will see items like platform fees (remember our website sales example?). Sales based websites cost money to host those sales and we apply that fee in this line. Also included here are sales-related costs, like commissions for your sales team or social media influencers and affiliate programs. Here you can get a sense of the overall break even report by customer as well. You can much better understand the end result of selling through each platform as the last costs are added in.
Let’s Not Forget: The Ultimate Goal of Margin Analysis
Because we get into the weeds of our clients’ sales channels and understand the sales on a micro level, we can properly report and forecast. Many of the companies that choose to outsource their accounting are in startup mode, which means success can be massively affected by how their sales and associated revenue is reported, analyzed and forecasted. They need to use their investments to the best of their ability to see a positive return to prep them for growth. Without learning and analyzing these nuances, it’s hard to provide this.
Accountfully’s goal for each client is to get precise data across different channels at multiple levels, so the model of historical sales allows us to make decisions based on sales channels and profitability, not generic reports pulled from sales websites. By leveraging reporting tools like Fathom, Quickbooks and noting KPIs and benchmarks, we help our inventory entrepreneur clients move forward with confidence to make better decisions for the growth and profitability of their companies moving forward.
If you are ready to get into the weeds of your complex business, tell us more about what you are looking for. Chances are, we’ve helped a company in a similar (or worse) situation.