Why Measuring Your Profitability is Key to Business Growth
So, you’re ready to jumpstart your business growth, but you want to do it right? Diving into your numbers is the first step to understanding whether your business is profitable. Armed with true facts and figures about performance, you can make better and more strategic decisions.
To make sense of your profitability and plan for business growth, you need to dig a little deeper within your financial reports. That means not only examining your business from a “product” level – ie Product A vs Product B – but doing the same comparative analysis for projects, clients, lines of business, regions, locations, etc.
Why Drilling Down in Your Reporting is Key to Understanding Profitability
The more detailed your reporting, the more you can learn about the financial health of your business. You can answer questions like:
- Where do we spend the most and where do we make the most?
- Is Project or Client A more profitable than Project or Client B?
- Which line of business is the most profitable?
- Where do employees spend most of their time? (labor costs)
- Do we need to invest in new equipment?
This information is gold for financial decision-makers – see what drives trends and where you’re generating the most profit. Highlight your strengths and weaknesses. Zoom in on specific areas like labor use, buying power, administrative expenses, or debt.
Using COGS and WIP in Your Financial Reports to Understand Profitability
If you’re wondering how to configure your financial reports to unlock this information, look no further than the dream team of COGS (Cost of Goods Sold) and WIP (Work in Process). These two elements can be tedious to track. But they’re a necessary evil when it comes to using your financial reports to measure profitability.
Combined WIP and COGS reporting allows you to accurately measure profit margin for all aspects of your business:
- Specific lines of business
- Locations or regions
- Compare projects for a single client
With these facts, you can make informed decisions about where to allocate resources and efforts. Set benchmark profit margins. Find out where you need to course-correct and what avenues have the biggest growth potential.
What is Cost of Goods Sold (COGS)
Cost of goods sold or COGS refers to the total cost to produce a product or service (sometimes called Cost of Sales, particularly in service businesses). Let’s say you own a manufacturing business. If your company makes furniture, you might have product categories like desks and tables.
Desk COGS would be the total cost to produce desks – with direct materials and labor as one combined figure. COGS doesn’t include indirect expenses like sales, marketing, and other overhead. Tracking COGS helps you:
- Determine your actual gross profit, not just revenue
- See where you need to adjust labor, materials costs, etc.
- Decide when to raise (or lower) prices on particular products or services
What is Work in Process (WIP)
Work in process or work in progress (WIP) tracks all costs throughout a project. Product or project-related costs including raw materials, labor, and any other direct costs are recorded to the corresponding WIP accounts as assets.
WIP is essentially “future COGS”, collected in a balance sheet asset account until it’s time to recognize the COGS when the project, service, or product is complete/delivered. When the desk (or any other project) is complete, the value of the WIP gets transferred to COGS. At this point, it goes from being an asset to being a direct cost.
Whether in QuickBooks Online or another accounting tool, tracking WIP costs throughout the production process helps you:
- Monitor costs for the duration of the project
- Ensure completeness and accuracy of project costs, and, most importantly
- Report accurate project margins
You can also check in on your WIP at any time to see where costs on your projects stand.
For a service-based business, your primary direct cost equals your time. By setting up accounts for each line of business, for both revenue and direct costs, you can quickly compare two or more product or service lines to see which is more profitable.
Putting It All Together – Tips for Configuring Your Reports to Measure Profitability
The key to making COGS and WIP work together in your accounting software is to record them consistently (in the expense transaction in QuickBooks). Then, you can generate a report that shows profitability by project. Compare all projects of a single client, across clients, and across lines of business.
Based on our experience, we’ve seen business owners make recurring mistakes related to WIP and COGS transactions. Here are a few tips to help you keep things clean and accurate:
1. Record project-related costs to WIP accounts (tracked as assets on the balance sheet).
WIP is an asset. When a project or item is complete, a debit transaction gets recorded to the COGS account matching the corresponding WIP value. This removes the accumulated costs from the balance sheet (WIP) to create the Income Statement (P&L) impact (COGS). When the project is finalized (or based on % completion), move WIP to COGS.
2. Recognize direct expenses on a client or project basis by assigning them to COGS, not general operating expenses.
This trips a lot of business owners/financial decision-makers up – it may seem natural to enter project-related costs as general operating expenses. But doing so obscures your view of profitability. When you track costs at the project level, you unlock useful insights.
The QuickBooks Projects feature offers a quick way to organize all these moving parts. Organize your data into specified projects and see exactly where you’re spending and making money.
3. Use third-party tools to assist with a high-volume of transactions (i.e. tracking large projects or many small ones).
Large projects, like building a home, can incur hundreds or thousands of transactions. Or maybe you have just a few transactions per project, but hundreds of projects that make it impossible to manually enter data on each. Instead of opening yourself up to potential errors (not to mention headaches) a third party tool, such as a Saasant plug-in, may be helpful to streamline the expense entry process by importing hundreds or thousands of rows into QuickBooks from a spreadsheet.