Costs can be divided into 2 types; those which you have to pay no matter how well the business is doing and those that are directly related to your sales.
Overhead costs you will pay regardless of how much you sell and could include:
- Business rent
- Business rates
- Utility Bills
- Waste removal
- Motor expenses
- Staff wages (not your personal drawings if you are a sole trader or partnership)
- Staff pension
- Equipment Leasing
- Bank/Finance charges
- Legal fees
Direct Costs are those directly related to sales and could include:
- Sales commission
- Delivery (specifically relevant if you are selling goods on the internet)
that is, anything that can be specifically and directly related to the product or service you are selling
It is important when you are planning or running your business, that you consider all the costs, these need monitoring on a regular basis to make sure that you are getting best value, and even a slight saving can often lead to a much healthier profit.
Profit – the difference between Gross Profit and Net Profit; there is a well known maxim that 'Sales figures are vanity – Profit is sanity.'!
Gross Profit is the difference between your direct sales income and the direct costs.
Sales - Direct Costs = Gross Profit.
This is important especially when you are looking to compare it with your selling price. However, you will not only need to ensure that your price covers your direct costs, but also takes into account your overhead costs.
Net Profit is the profit you have made after all your costs, including overheads have been taken into account.
Sales – Direct Costs – Overheads = Net Profit.
This is the amount of income the business actually makes.
Keeping control of your costs, and ensuring you are pricing correctly is a vital part of any business. Even minor changes in price and costs can have a big impact on the profit you achieve.
Don't forget that whilst looking at your business costs, you should also consider your resources management; Resource Efficiency