“All I care about is my bottom line.”
Business owners tell us this all the time. And sure, we appreciate the candor.
But the reality is, a million little details go into protecting that bottom line, and making sure you walk away with the amount of profit you deserve.
Two of the most important factors to look into?
Cost of Goods Sold and Operational Expenses.
Keep reading to understand these two definitions impact your business’ financial wellbeing.
COGS vs. OPEX – What’s the Difference, Anyway?
“Money out is money out, right?”
Forgive us finance nerds for getting too granular, but we’ve got to differentiate between the money leaving your account.
And in a minute, you’ll understand why.
But first, let’s define each. COGS, or Cost of Goods Sold, are the expenses that relate directly to the product or service you’re selling.
For example, a restaurant owner purchases food for his recipes, or a T-shirt manufacturer buys cotton for his clothes.
OPEX, or Operating Expenses, reflect the indirect costs associated with running a business. Even if you’ve shuddered your doors for a month or put a halt on sales, you’re still responsible for rent, insurance, salaries, and utilities.
Why COGS Matters
When you start paying attention to COGS, you’ll notice that the numbers fluctuate based on the amount you sell.
Here’s why that’s important:
Subtract your costs of goods sold from your revenue, and you’ll end up with your gross margin (GM).
Next, divide your gross margin by your revenue, and you’ll end up with your gross margin percentage.
Savvy business owners are always on the lookout for their GM% because it helps them to answer the following questions:
Am I charging enough for my product/service? A healthy gross margin percentage is steady or declines over time. If it starts to creep up, it typically means your cost of goods sold is increasing, but your prices have remained stagnant. Use this metric to determine whether you need to raise your prices, or find a new supplier who will charge you less.
How do I size up against the competition? Your gross margin percentage is a good measurement for comparing your business to other similarly-sized companies in your industry. This essential piece of data allows you to determine whether you’re keeping up with the market . . . And if your margins are considerably lower, it alerts you to the necessary changes you need to make.
But Don’t Forget to Pay Attention to OPEX, too
Unlike COGS, OPEX doesn’t fluctuate with your sales numbers. When you’re regularly paying for expenses like salaries, rent, or insurance, you’re unlikely to encounter any sudden spikes.
However, that doesn’t mean they’re not important numbers to note.
In fact, understanding how much money you’re paying just to exist is crucial for driving your sales functions.
Remember this: Before you make a single sale, you must understand how much money you’re investing in running your business.
The more clarity you have around your operational expenses, the easier it will be to make smart financial decisions that drive profit. Wouldn’t it be nice to know exactly where you should add some extra padding when investing in growth, and where to cut costs to keep your business firmly in the black?
The Bottom Line for Your Bottom Line
At the end of the day, it’s way easier to understand why you’re walking away with a certain amount of money when you’ve broken down your income statement into sections.
And while it might not be fun to get into the nitty-gritty of the numbers, the true story behind your financial situation always reveals itself within the patterns that develop month to month.
They say the devil is in the details for a reason, right?
So instead of just focusing on your top line and profits, take some time to understand the why and the how between what you make . . . And what ends up in your pocket.