Gross Profit Essay

1214 words - 5 pages

Gross Margin
First in line of the analysis of your business P & L is to carefully evaluate its gross margin. This calculation is done by subtracting the company's cost of goods sold from sales and by dividing its result by sales. Cost of goods sold is best measured as a percentage and proper care should be exercised to ensure that the periods P & L has properly allocated all direct sales cost to cost of goods sold. Typically most all of these costs will vary proportionally to the amount of product/services sold and delivered. A proper and consistently applied cut-off of accounting data is critical to this evaluation as otherwise the data/margins are unduly skewed to start.

Pretax Margin
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• An understanding of the company's effective tax rate, which is determined by dividing one's federal and state income tax bill by the related sales for the period.

• A company's marginal tax rate, which is the amount of tax that would be due as a percentage and dollars, on any additional profit. This is a critical component as the IRS tax system is graduated, thus requiring more tax, as a percentage to be paid on additional net income.

Interest Expense

There are several hidden risks in acquiring debt that companies need to contemplate before acquiring debt/line of credit. Any of these issues either individually or collectively can cause irreparable damage to your firm's ability to operate and continue forward. Often business owners who are flush with cash fail to make wise and judicious cash/debt decisions as they are inclined to believe the good times will last forever. Also before making any large non-recurring cash expenditure, care should be exercised to review the proposed transaction with projected cash needs as detailed in the company's business plan.
Unfortunately, I have witnessed all too often companies spending all of the money they will soon critically need, simply for the lack of proper planning and advisement. An owner will also want to carefully contemplate a proposed line of credit/debt to be sensitive to its flexibility to meet an ever-changing business environment. Attention should be paid to ensuring the debt being requested is adequate as it is always better to have too much credit than too little. Also, the debt provisions should be carefully scrutinized to ensure that all provisions, repayment scenarios, and interest rate calculation and fluctuations are all well understood. Often banks and lending institutions will remove/negotiate several debt provisions in an effort to earn your business.
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A Profit & Loss Statement (P&L) measures the activity of a business over a period of time – usually a month, a quarter, or a year. This financial report may have several different names: profit & loss, P&L, income statement, statement of revenues and expenses, or even the operating statement. The P&L basically tells you revenue, expenses, profit, and loss. Keep in mind that in almost all circumstances, profit is not the same thing as cash flow.

The basic formula for the profit-and-loss statement is:

Revenues – expenses = net profit.
P&L statements generally follow this format:
- Operating (variable) expenses
= Gross profit (operating) margin
- Overhead (fixed expenses)
= Operating income
+/– Other income or expense (non-operating)
= Pre-tax income
- Income taxes
= Net income (after taxes)

Here are definitions of these categories:

Revenue is the money you receive in payment for your products or services.
Operating, or variable, expenses are the expenses that rise or fall based on your sales volume.

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