The numbers you should know to track your business’s success
The right numbers help you measure your business’s success
Only some start-up costs are deductible the year you open your business
The cost of goods sold (COGS) only includes costs directly related to purchasing inventory and manufacturing goods
Your breakeven point helps you see how much you need to sell without losing money
Profitability can be measured in different ways
Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) and similar metrics help you assess the difference between cash flow, taxable earnings, and more
There are all kinds of different numbers and key performance indicators that you should track when you run a business. You need to know how much you earn and how much you spend, but the most important business metrics are a lot more complicated.
Tracking the right numbers is essential to ensure you’re filing your business taxes correctly, but you also need accurate numbers when you want to take out loans, attract investors, or eventually sell your business. Setting up an accurate accounting system on your own can be nearly impossible, but a professional can help. This guide looks at some of the numbers you should track with your business and explains why they are valuable.
Start-up costs refer to all the costs you spend to launch your business, and they include tangible expenses such as buying equipment and intangible expenses such as researching market conditions. You may also incur organizational expenses that can include the cost of establishing your business structure — for example, forming a corporation or registering as a limited liability company (LLC).
The Internal Revenue Service (IRS) distinguishes between start-up costs and organizational expenses, and in your first year of business, you can deduct up to $5,000 in both categories when filing your business taxes. Any amounts over these thresholds can be depreciated over the next 15 years.
You need an accounting system that allows you to track your expenses when you incur them, but that also helps you understand the tax implications of expenses that must be written off incrementally over time.
Calculating the cost of goods sold (COGS) can be complicated, and you need to ensure you’re using the right numbers if you want to measure your profit margins correctly. An accurate COGS number requires you to know the value of your inventory at the beginning and end of each year. You also need to know the cost of purchases, the cost of labor, and related costs such as shipping containers, freight costs, and warehouse expenses.
These costs vary depending on the type of products your business sells. The cost of purchases if you run a liquor store, for example, refers to the amounts you paid your vendors to buy products. The cost of purchases for a manufacturing facility, in contrast, includes materials and supplies used to make your products. The labor costs included in your COGS should include payroll for manufacturing professionals but not for salespeople. You should include utilities for warehouses where you manufacture products but not utilities for office buildings or storefronts.
You need accurate COGS numbers when filing your business taxes as these numbers get reported in their own section of the return. You also need accurate COGS numbers for internal purposes so you can see which products earn the most money and where you’re losing money. Categorizing these numbers accurately can be challenging, and an accounting professional can help ensure you’re on the right path.
The break-even point is the point at which your sales directly cover your expenses. Understanding this number is critical if you want to set clear goals and avoid going too far into the red, but you need accurate COGS numbers to assess your breakeven point correctly.
Your breakeven point consists of your fixed costs divided by the difference between the price per unit and variable costs per unit. Here’s an example: Say that your fixed overhead costs such as rent and insurance are $10,000 per month. You charge $80 per unit, and you spend $30 per unit.
The difference between the price per unit and the cost per unit is $50, and when you divide this into your fixed costs of $10,000, you get 200. This means that you need to sell 200 units per month to break even.
Gross profit margin
Profits are the key purpose of any business, but there are a variety of different ways to measure profits. Gross profit margin refers to the percentage of revenue that exceeds COGS, and you calculate this number by subtracting your COGS from revenue and then dividing by revenue.
Net profit margin
Net profit margin, in contrast, counts all of your business’s expenses. You start with revenue and then subtract COGS, operating expenses, other expenses, taxes, and interest, and then you divide the difference by revenue.
Net profit margin shows you what percentage of your business’s revenue is profit. A net profit margin of 20%, for example, means that 20 cents of every dollar your business collects in revenue is profit. The remaining 80 cents covers expenses.
Earnings before interest, taxes, depreciation, and amortization (EBITDA)
EBITDA is an important number to understand because it shows how much of your business’s cash flow comes from ongoing operations. Businesses have to categorize their expenses in a range of ways, and the profit you report when filing your business taxes doesn’t necessarily reflect your cash flow.
Say you purchase a large piece of equipment with cash. You have spent the cash, but unless you qualify for a Section 179 deduction, you cannot deduct the entire expense when filing your business taxes and you have to deduct it slowly over time. Your business bank account shows a relatively low balance after this purchase, but your tax return shows a lot of profit for this year as it doesn’t consider the entire cost of the purchase.
There are also situations where the reverse can happen. Say you take out a loan to buy a $100,000 piece of equipment, and you take a Section 179 deduction so you can write off the entire cost when filing your business taxes during the year of purchase. Your business profits look relatively low on your tax return due to the write-off for this year, but you haven’t actually paid for the purchase yet, so it hasn’t affected your cash flow.
Numbers such as EBITDA and others can help you assess your earnings and business profitability in different scenarios.
Get professional help with the numbers
You need to track the right numbers to run your business successfully and measure its profits, but this process can be challenging. Franco Blueprint is dedicated to helping our clients understand their numbers inside and out.