Many advisory firm owners have trouble with business accounting. This is often because different industries — and resources like industry surveys — use different terms for the same measurements.
For instance, some owners are confused by the term “gross profit.” It’s calculated by subtracting the cost of goods sold from total revenues.
In most accounting software, “revenues” are referred to as “income.” In some industry studies, “cost of goods sold” is somewhat related to “direct expense.”
While not meaning to oversimplify corporate finance, I believe there is good news: You don’t have to sort this all out to successfully run an independent advisory business.
Instead, you can greatly simplify your life by focusing on your “gross profit margin.” The GPM is defined as the total revenues (income) that your business brings in during a given period (quarterly, annually, etc.) minus the “cost of goods sold” divided by total income. In my years running advisory firms, this is the key measure of the efficiency of your business.
Unfortunately, GPM isn’t as simple as it should be due to varying definitions of the “cost of goods sold.”
Technically, cost of goods for an independent advisory business should only include the compensation of employees who contribute to providing and delivering services directly to the firm’s clients. These employees are your professional employees, such as lead advisors, associate advisors, etc.
Many industry surveys, though, exclude the costs of other employees (client- services support staff and management) in their cost of goods sold calculations. And technically, they are right, according to accounting methods.
Time to Recalculate
In reality, though, these same employees rarely perform just their stated professional function. Many do all sorts of other tasks in the business, including professional management.
These variations and dual roles cause confusion about what the gross profit margin should include. Most firms have talent that falls into overhead expense (a different category) and also falls partly into the cost of goods sold. This leaves firms owners confused on what to include in GPM.