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Do Your Profits Pay for all Your Overhead?

By: Adam J. Heist

Business people can fool themselves often about what their profits really are. Profits are not only cash available that you can spend as salary and reinvest in a business. Profits also have to pay all taxes, fees, and service all loans outstanding. “Goodwill” earnings through the development of a brand, internet site or distribution network can warrant years of investment in companies that on the books have losses year after year. Then the owners sell the company for some huge billion dollar figure and make a big, in the pocket, profit. When looking at a company’s profit and loss statements, we first look at its top line growth. Is it making more gross sales? Is the profit margin increasing or decreasing? Is a decreasing profit margin compensated by a larger volume of sales?



Next one must look at the net profit margin. This also has to be measured against the interest expense and other charges from borrowing capital. To continue with this analysis, you need to tell the difference between your costs- that is your necessary costs of production; and your expenses- whether you need to rent extra plant space, higher more sales people, and is this a smart move. When determining your profit, after looking at your gross sales, you have to look at the cost of goods sold. This defines your net profit potential.



The idea is to monitor gross margins. If the margin is tightening the market is getting more competitive, or the company is becoming more unproductive. Overhead is another thing that business people have to worry about – Overhead is all the indirect expenses that businesses incur to be able to sell our product or service. Anything that is an expense that you incur that is not directly related to the product or service is overhead. For example, a company might have rent expense, or the expenses related to telephones, and lighting, and management salaries. All of these are indirect, and would therefore be termed overhead. You will also see this broken down sales and general administrative expenses.



This type of analysis shows how one company can be doing better than another company, despite similar sales revenues, and the same earnings before interest payment and taxes. However, even though increased overhead can and does reduce profitability, it may be necessary overhead. What if one company can garner more sales by sending out more mailings or doing more advertisement? This is overhead, but it also succeeds in getting more results.

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