This is the seventh in a series of articles that will hopefully educate readers and illuminate the process of doing business in a simple to understand, nuts-and-bolts way.
To read all the articles in this series, click on any of the following:
In the previous articles, we have covered motivation and are in the process of getting organized.
In this article, I will continue to discuss the preparations necessary for building a Financial Plan based in reality.
More on Understanding the Past…
Last time, we looked at total sales using a method called “Weighted Averaging” as a way to make the recent past more important than years farther back in time. We gathered all sales information, categorized it by sales stream, year and month and created a little database that looked like this:
We can now look at individual sales streams using the same methods as we did for the totals. I’m not going to go through the process again here. You can refer to Part 6 for the details. The reason you want to do that seperately will become clear below.
What you should end up with, in the end, is a chart that shows a Weighted Average for each sales stream and the total sales. Set that aside for a moment.
Costs of Goods Sold (COGS) as it relates to sales…
We should all be pretty familiar by now with COGS as direct costs of producing the product or service your business provides. If not, go back through the series and get an understanding regarding this, because this is the next step.
Go back to your records of the same time period you used for your sales analysis and pull out all COGS expenses for those years. Segregate them for years only. You don’t have to go through mathematical analysis regarding COGS as you did for sales. We are looking for a total of COGS expenses only for each fiscal year for which you have data in your chart. There is a reason for this.
Sales, COGS and the time shift…
Unless you keep more detailed and accurate records than any business ever seen, there is no way you can relate each job, project, or service in your sales records to the expenses associated with them. Let me repeat that. It is nearly impossible to relate COGS to sales in great detail!
Why is that, you may ask? Seems you should be able to. Well, if you follow this series to the end, you will be able to come pretty close, but in some things, you can only estimate. Let me explain.
Think about this… a business may spend money days, weeks or months on materials and labor before the sales of a product or service renders a sale. The COGS for that sale may have even happened in a previous fiscal year! It is very difficult to accurately associate direct costs to a specific sale in most case without a rational and reasonable Chart of Accounts that has categories for COGS that are segregated by Sales Streams! That is why we set it up that way in the previous articles. But we are talking about a Financial Plan, a very different thing, but that is based on that same Chart of Accounts we built.
We have to make an assumption now. It’s a pretty safe assumption. The assumption is this:
Assuming that the direct costs of sales is fairly stable (it generally costs about the same to produce similar products/services), we can take the total costs of those products/services and create a ratio between the costs and the sales.
It works like this… Let’s say the total sales in 2008 for Sales1 is $54,285. Let’s further say that the total COGS for Sales1 (after you have pulled all your records and totalled them all up) is $34,200. That is about 63% of those sales. Doing the same for 2009 yields, let’s say a 65% ratio. It would be safe to assume that the COGS for Sales1 is likely to be a fairly stable 64% of sales in the future.
Working through that process for all sales streams and COGS for those streams now gets you to a conclusion. You can begin to see which sales streams are more costly by percentage than others. Doing the same thing allows you to project COGS for the whole business.
Do the calculations, and put it all into a chart similar to above, adding lines for Sales1 COGS , Sales2 COGS, etc. as well as for total COGS.
What you will end up with is the basis for Projected Base Sales for the next fiscal year (Weighted Average Sales) and the COGS for those sales by applying the percentages you produced for each sales line and the total sales. We are going to use this BASE information to project Gross Profit for the coming fiscal year, but there a few more things to consider before we get there and to produce a true Financial Plan.
Please contact me offline at micr...@aol.com with anycomments, suggestions or ideas for future articles that you may not want to share here.