Understanding your businesses financial profile is key to establishing pricing strategies that will ensure you are charging enough to make a profit and stay in business. So many photographers look to undercut competition to gain market share without understanding how this pricing strategy is going to affect their goal of turning a profit. Above is a model of how costs and revenues can be categorised to understand this alittle better. All of this information can be found in the profit and loss account of any businesses financials statements.
Costs are made up of :
COGS (cost of goods sold) which refers to the inventory costs of those goods a business has sold during a particular period. Costs are associated with particular goods using one of several formulas, including specific identification, first-in first-out (FIFO), or average cost. Costs include all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Costs of goods made by the business include :
- Raw Material costs
- Direct Labour costs
- allocted overhead costs
- Direct sales costs
The costs of those goods not yet sold are deferred as costs of inventory until the inventory is sold or written down in value.which are direct costs of producing the goods and services that the business produces/provides.
Variable Costs include things that vary with the volume of output, these can often include many of the same things listed under COGS, items such as electricity and gas useage that cannot be directly allocated to COGS may also be added. When we were looking at our businesses financial model we found that most of our variable costs were also our COGS.
Fixed Costs – Are made up of costs that don’t change with variations in a businesses output. Things such as Rents, Rates, insurances, administration labour costs etc
Gross Profit – is calculated by taking away the COGS from the Total Revenue (Turnover). Gross profit can be converted to gross margin which is the same figure represented as a percentage. Gross Margin Percentage = (Revenue-Cost of goods sold)/Revenue. Your Gross margin will tell you what contribution your sales will make to your fixed costs.
Gross margin is an important figure to know when you are trying to establish what level of sales you would need to achieve to cover your total costs. Lets assume your fixed costs are £1000 per month. Your Gross margin is 60% of your sales. 1000/.60(60%) = £1666.66. You would need to achieve £1666.66 of sales to cover your COGS and fixed costs. This is also known as the breakeven point. So lets have a quick look how this might actually be used in practice. Lets assume you decide to rent a larger shop unit than the one you are currently renting now and you want to work out how much more business you need to bring in to pay the extra cost. Lets assume you are currently paying rent of £600 per month and the new shop is going to cost £800 per month, an extra £200. How much extra business do you need to bring in pay for the extra rent, £200? Wrong! Lets assume your gross margin is 60% You would need to bring in not £200 but £333,33. Why? Well because the extra £200 is a fixed cost (your rent), but as you sell extra products to cover the additional rent, you are also incurring extra COGS to produce those products. So for every additional £1 of sales, you are incurring £040 cost of goods sold (COGS). Which means that only £0.6o (gross profit) is actually going towards your extra rent costs. So when you have sold the extra £333.33 of products you will have covered your rent £200 and the additional COGS £133.33. The calculation is fixed cost (£200)/GM .6 (60%) = £333.33
Net Profit is calculated by taking away Total Costs from Total Revenue. Also known as the “bottom line” due to the fact that it can be found at the bottom of the profit and loss account. This is what is left after all costs have been accounted for. Of course a negative figure means that the business is loss making.
Deciding which costs fall under which category can vary considerably from business to business, In our business, some parts of our advertising costs are allocated under COGS, while others are categorised as a fixed cost due to the fact that they are contracted on a yearly basis and don’t alter depending on output. Same with our labour costs. We put photographer payments as a COGS but administration labour costs under fixed costs. It is best to consult your accountant for further advise if you are still unsure how to categorise each of your costs.
Disclaimer, release and acknowledgment
Mike Turner, is not a financial planner, adviser, registered accountant or financial professional. The information presented in this blog is based on his personal experiences as business owner, researcher, and others he has modelled in detail. You may have to modify them, do further research on them or adapt them to suit your personal financial situation. Any information presented on this blog, or any support materials, are given purely as illustrations and should not be construed as specific investment recommendations. The laws relating to investment, taxation, benefits, and the handling of money are constantly changing and are often subject to changes in government policy, and whilst every care has been taken to ensure the accuracy of the material contained herein at the time of publication and presentation, Mike Turner will not bear any responsibility or liability for any action taken by any person, persons or organisations on the purported basis of information contained in this blog, or any supporting material.
Without limiting the generality of the foregoing, no person, persons or organisations should invest monies or take other action on reliance of the material contained in this blog, or any support material, but instead should satisfy themselves independently (whether by expert advice or otherwise) or the appropriateness of any such action.