So you’ve just been told the ROI from the capital invested in last year isn’t yielding the gross margin that was anticipated…and your eyes might be glazing over.
The accounting industry is riddled with jargon and terminology that can cause you, the consumer of this information, to become lost and alienated by the “advice” you are given.
Every month I’ll post a blog breaking down 5 common finance terms, helping you to understand what is really going on and making the numbers less scary.
1. Balance Sheet
This can also be called the Statement of Financial Position. It shows the financial position at a point in time (a bit like a photograph of the business).
It shows how much cash you hold, how much you owe or are due, how much value you hold in assets such as property, plant and equipment and how much equity has been injected into the business.
It is balanced by using the following formula: Assets – Liabilities = Equity.
This is also known as sales, income or turnover. It represents the amounts you have invoiced as a business. If you have invoiced it but haven’t received the cash yet, it will still be classed as revenue.
It’s important to note that costs aren’t deducted from the invoice amount to reach the revenue number. Revenue is the amount before the costs are deducted.
WIP or “Work In Progress” shows the total value of materials / labour for products that haven’t been finished. If you are a service company, your WIP will be the time spent on a project.
WIP only becomes a finished good when the product is finalised or the service is billed.
WIP will be held on the balance sheet and is usually measured at the costs incurred of the labour / raw materials.
These are costs of the business that cannot be directly attributed against goods / services sold. For example, if you pay for rent of an office this will not be directly assigned to a specific sale you make and it is therefore classed as an overhead.
Other overheads include office supplies, advertising / marketing, HR, IT systems and legal / professional fees.
5. Gross profit
This can be remembered by the formula: Revenue less Cost of Sales (i.e. Direct Costs).
Gross profit looks only at revenue and the direct costs, so the overheads aren’t included in this figure. The gross profit is used to assess whether the business is profitable looking at the direct production element of it’s activities.
6. Net profit
Similar to gross profit, revenue and cost of sales are included in the calculation but so too are overheads. This gives a really clear picture of the performance of the business and is often used by lenders when assessing if the business will be successful in raising finance. The formula is:
Net profit = Revenue – cost of sales – overheads
For more information on accounting jargon, cloud accounting, tax returns and a “no obligations” consultation, contact me via the following link.
ASU Accountants is based in Cranfield, Bedfordshire, UK. We embrace technology so don’t worry if we’re not local to you – we actively use Skype in our day to day business!