So after Gross Profit is calculated we turn to look at what is known as Overheads.
These are just the running costs of the business and cover a range of expenses including accommodation expenses (such as Rent, Rates and Insurance); marketing costs (e.g. advertising, networking expenses, web site costs); administration costs (perhaps telephones, stationery, printing, business insurance, subscriptions, accounting fees); and the costs of borrowing (loan interest, overdraft interest); investment costs (depreciation).
There’ll be more about Depreciation in a later post, because this is a whole jargon area in itself.
There are a couple of important things to look for here:
- Overheads should stay broadly the same in every time period of the same length. This is mainly because overheads are time related expenses not activity related – Costs of Sales are activity related.
- Some expenses move partially because of time and partially because of changes in activity. For example administration wages may increase because the amount of sales enquiries, invoicing etc has increased. This can make forecasting net profit a little more difficult so don’t be too surprised if when sales rises significantly, some overheads take a leap too.
- Net Profit is what is left after you deduct overhead costs from Gross Profit. If you are trying to understand a UK Limited Company’s accounts, Net profit is sometimes called Profit Before Tax. To calculate the Net Profit % (or NP% or Net Margin) do the following calculation:
Net Profit x 100/ Sales
Whereas GP% should be steady from period to period, you really want to see NP% increasing from one period to another, unless you really want to make less money each year (!)
Keep those calculators fully charged!