Turning Your Numbers from gobbledygook to insight
We love Xero, it is easy to use and drives efficiency.
But we are bean counters, so for us it should be easy!
But are you still confused with the reports and what they are telling you?
To help you get the most out of Xero and get true insight into your business, lets step through your Xero set up. This will focus on the Profit & Loss (P&L) which is your key business measure.
Is the standard Xero P&L format right for me?
The answer is maybe – it does really depend on your business.
Let’s talk through the key sections of a P&L – once you understand this, you can then work out a format that works for you.
For simplicity, I will split the P&L into the top half and bottom half. Below are the key components:
- COGS; and
- Gross Profit / Margin
- Operating Expenses; and
- Net Profit
The standard set up has one Sales account. You are able to add additional Sales accounts if you want to capture the split between different parts of your business. For example, if you run a coffee shop you might want to capture Coffee sales and Food sales. If you run a distribution business, you might want to split sales between retail and online.
The split really depends on your business and what makes sense for your business. You do need to be careful and not add too many accounts as you may end up with an equalling confusing P&L with too many accounts.
Cost of Sales – also know as Cost of Goods Sold (COGS)
Cost of sales are those costs directly related to your sales. What makes up cost of sales again depends on your business.
If you are selling products, then the cost of sales will include the cost of the products you sell.
If you are a consulting firm, then the cost of sales will be the wages and salaries of your team or sub-contractors.
A good indicator for an item to be included in cost of sales, it a cost that varies directly with sales.
Gross Profit – also known as Gross Margin
In short this is sales less cost of sales.
This is the profit you make before you cover your operating costs.
Operating Expense (Also know as overheads or fixed costs)
These are the costs incurred to run your business. These costs generally do not move in line with sales which is why they are often called fixed costs. A lot of these costs are not necessarily required to make a sale which is why they are also referred to as discretionary costs.
It is important to understand the level of these costs to ensure that you are making enough gross margin to cover them.
When business is tight, it is always prudent to review these costs to ensure that the business remains profitable. For example, can I afford to travel given the current sales?
When a business is expanding, it is also important to ensure that the increase level of operating expenses can be supported by the expected growth. For example, will the growth in sales support the level of rent that the new office will cost me?
Net profit (or simply just profit)
This is your gross margin less your operating expense. This is the amount you have made after all your expenses.
You can have as many different expense accounts as you require. There are a few key rules to think about here:
- There are a couple of key accounts that you want split out to make your tax return preparation easier – for example ‘Donations’;
- Do not set up too many accounts – you don’t want a whole lot of small accounts that makes the P&L overwhelming and inefficient to analyse;
- Do not have too few accounts – you don’t want large buckets that then have to be reviewed further to get an understanding of where you are spending your money
Think about the GST implications. For example, you may want to split domestic travel, which has GST and overseas travel which is GST free. Remember All figures in your P&L exclude GST.
Remember, that profit does not equal cash – something you also need to keep and eye on.
Let’s look at two different businesses and how their P&Ls could look:
- IT company
This company sells mostly consulting services as well as some hardware and software. The consulting is done by a team of employees. All the administration work is outsourced to the bookkeepers. The P&L would look something like the below:
- Handbag company
This company imports handbags and then sells these to retail stores and directly to customers online. There is a small admin and marketing team that runs the business. Their P&L would look something like:
A good bookkeeper will get to know your business and can help you set up your accounts, so they turn from being gobbledygook into being a clear insight into your business!