What Is Your True Cost of Sale?
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If you are using accounting software, then you have the systems in place to ensure you can make good informed decisions regarding your business’s growth. However, if you aren’t sure what you should be looking for and therefore aren’t seeing value in your cloud accounting, this post is for you!
Let’s assume for the purposes of this blog you are offering a service to other businesses, for example a marketing agency.
Without going below the gross profit line, what is it you should be tracking and looking for each month end? One of the most important indicators of a business’s efficiency is its gross profit margin. So you raise invoices and they appear in the sales line but what should appear in cost of sales to determine what your true cost of sale is?
When we begin working with a new client we ask them what their gross margin is. Often, we get an answer of 90% or higher. This indicates to us straight away that the client does not truly understand cost of sales. Therefore, we then need to reallocate items to show a true reflection of what it costs to deliver revenue.
The following should be in cost of sales:
- Subcontractor costs (not admin staff or PAs)
- Delivery team wages cost
- Delivery team PAYE cost
- Direct expenses such as client AdWords costs
One might argue that a percentage of overheads attributable to the delivery team should go in cost of sales, however I would follow the KISS principle and move to this approach, if you are not already doing it.
You will now have a % which is your Gross Profit Margin.
Gross Profit Margin = Gross Profit / Sales
So what now?
If you are a marketing agency you can set targets for that percentage. I’d recommend that 67% is a great margin. This shows you are effective at delivering work and are pricing correctly.
Any form of value based pricing should increase your margin to over 67% and this contribution should ideally be enough to cover your overheads and dividend payments.
If your percentage is too low, you need to look at a review of the following:
- Current pricing strategy
- Systems and process
- Sales strategy
If you are over 67% then great! Sit back, relax, identify what is working and keep doing it! If you aren’t and would like advice on how you can get there, please book in for a free consultation.
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