Recently we discussed accounting for Cost of Goods Sold.
As with a lot of topics we discuss, there’s the accounting way transactions need to be done and then there’s the way we want to handle it for cash flow and Profit First.
Cost of Goods Sold is no different.
Cost of Goods Sold – the cost of delivering your products and services to your customers – mostly affects the set up of Profit First and the calculation of allocation percentages in the very beginning of implementation.
Since a large majority of the focus within Profit First is to reduce your expenses rather than increasing your sales and revenue, the first thing we want to know is how much of the revenue you bring into your business is truly yours. If, for example, for every new member that signs up, you owe your sales person a 40% commission, those dollars are never yours to do anything other than pay out the commission.
As we discussed in our prior blog post, the other example is the cost of retail sales.
This is why, even though in Profit First, it’s called Materials and Subcontractors and we’ve modified that even further to be Commissions and Retail. Those are the two largest areas of difference between Total Revenue and Real Revenue in a fitness business.
Now, what do we do with that information. First, we need to determine what percentage of Total Revenue is being paid out in Commissions and Retail. If it’s less than 25% we don’t consider it material and worth separating into a separate Commissions and Retail account. This leaves it is Operating Expenses and forces you, the owner, to consider each of these items when you’re evaluating expenses on a regular basis. This is the best case scenario. It’s always good to be reevaluating vendor relationships and effectiveness of commissions as a motivator for salespeople.
If you find Commissions and Retail are more than 25% of your Total Revenue are you really in the fitness industry or are you a retailer with a side training business? Or maybe, your business is so new you are bringing on a lot more new members and therefore your commission is high, will it continue at that pace long-term? Most likely, no and therefore, we’d still recommend leaving these two categories as an operating expense.
It’s still very helpful to have these costs segregated on your income statement so other calculations and analysis can be done. It doesn’t affect your Profit First system though the same way these two categories would for a construction company or retail business.
Please let us know if you need further help determining how to handle commissions in your fitness business.