The usual divisions in ‘Cost of Sale’ are:
- Labor (the hourly rate you pay and does not include benefits)
- Equipment (the stuff you install that has a serial number)
- Material (the stuff you install without a serial number)
- Sub-contractors (sometimes it is better to hire someone, who is not a full-time employee, to do part of the work. They have a backhoe and know how to use it.)
- Permits (Often, the city or municipality requires you to pay for a permit which ‘permits’ you to do the work)
- Warranty reserve (this is money you set aside in the event that you have to go back and fix something and don’t charge the customer. Usually, work is warranted for 12 months only.)
A financial model I like puts the Cost of Sale at 60% of Revenue or less.
Gross Margin: The money left over after you subtract the Cost of Sale from the revenue. I’m thinking 40% or more is good.
Overhead: All remaining expenses. A great target is for overhead to be 30% or less.
Net Profit: Any money left over after you subtract the overhead from the gross margin. This is usually the money the government takes 35% or more from you. We would like this to be 10% or more.
Net Loss: This happens when the overhead costs are more than the gross margin. If you keep doing this your business will die. Currently, the government has not found a way to tax a loss.
It is important to remember that the purpose of Profit is to pay the expenses on the balance sheet.
You cannot put loans or revolving credit lines on the P & L (usually P & L captures only 12 months at a time).
The joke: American profit is “Net Profit”, and Russian profit is “Nyet profit.”