Glossary of Financial Terms
Break-even point: The point at which your business's income matches or exceeds its expenses (including a reasonable salary for the owner/manager).
Cash flow: Incoming payments minus outgoing payments over a given period of time. Many businesses may be making a profit according to the IRS but are chronically short of cash. This is usually the case if too much cash is tied up in slow-moving inventory since the cost of the inventory cannot be deducted until it actually sells. Paperback exchange stores often have poor cash flow because many of their customers build up a large credit balance and never have to actually pay cash for their purchases. This problem can be combated by keeping tighter control of inventory costs or by requiring customers to pay for half their purchases with cash, no matter how much credit they may have built up.
Cost of goods sold (COGS): Also known as cost of sales. This is the amount you paid for the inventory that you sold over a set time period. It only includes inventory that sold during that time period, not inventory that you paid for but is still sitting on the shelves. Unfortunately, you cannot deduct inventory as an expense the minute you pay for it. Instead, the IRS makes you wait until you actually receive income for the item. Thus, businesses with higher turns often have better cash flow because they do not have as much money tied up in inventory. If you don't want to have to keep track of exactly what you paid for every single book in your store, you can instead average your cost of goods. Using this method, you simply keep a log of the number of items you buy and the amount you paid. For example, if you buy 5 books for a total of $2.50 at a flea market and then you buy 10 books from a customer for a total of $20 in store credit, then simply average those amounts together (a total of $22.50 was spent for 15 books) to give an average inventory cost of $1.50. Then if you sell 10 of those books, your cost of goods sold will be $15.00 (10 * 1.5) no matter which 10 books you sell. There are other methods approved by the IRS as well, so this is another matter to discuss with your accountant.
Gross profit margin: To calculate your gross profit margin, take your total sales over a set period of time minus your cost of sales and then divide by your total sales and express it as a percentage. For example, say you paid $1,000 for a collection of books and then you turned around and sold that collection for $2,000 to another dealer. Your gross profit margin would be your total sales of $2,000 minus your cost of sales of $1,000, which result is then divided by the total sales of $2,000, giving a 50% gross profit margin. If you sold the collection for $3,000 instead, your gross profit margin would be ($3,000 - $1,000)/$3,000, which equals 66.67%. The higher your gross profit margin, the more money you will have available out of every sale to pay yourself, your rent, and your other expenses. 60% is a good target gross profit margin for a used bookstore.
Inventory turnover: Often referred to simply as turn. The ratio of a company's sales to the retail value of its inventory. Also thought of as the length of time that the average item remains in inventory. If your bookstore makes $100,000 / year and on average has an inventory stickered at $100,000 then your inventory turn is 1 and an item usually remains in inventory for a year. If an inventory valued at $200,000 is only producing $100,000 per year in sales then the inventory turn is .5 and an item usually remains in inventory for 2 years before selling. If an inventory valued at $50,000 is producing $100,000 per year in sales the inventory turn is 2 and an item is only remaining in inventory for 6 months before selling. The higher the turn, the better, but some industries tend to turn inventory faster than others. Unfortunately the used book business only averages turns of 1-2. Whereas the new book business may see turns of 3-4.
Net profit: Net profit is often referred to as the bottom line. It is the amount you have left after you subtract the business's total expenses (including a reasonable salary for yourself) from total income. Ideally you should set up your business so that you as owner/manager are taking a set salary. Then at the end of the year any net profit above that can be distributed to yourself as a bonus or plowed back into the business. If you wish to eventually sell your business or hire a manager to take over for you, the business needs to be making a profit above the owner/manager's salary. I don't have any industry-wide figures for the used book business, but independent new bookstores usually have a net profit of only 2-5%. For tax purposes, net profit may be calculated differently and may not include the owner's salary, depending on whether your company is set up as a sole proprietorship, LLC, or corporation.
Net sales: Your total sales, less returns, discounts, etc. When paying a sales commission to an online aggregator such as Amazon or Alibris you have the choice of recording the amount the customer paid as income and then the aggregator's commission as an expense or simple recording the net income paid to you by the aggregator. There are advantages and disadvantages to both methods and this decision should be one discussed with your accountant.
Operating capital: A business does not necessarily earn 1/12 of its yearly sales each month. Depending on your industry and location, sales may swing wildly from month to month. Thus, you may need to set aside enough money to meet several months' expenses to smooth out the rough edges of your sales cycle. This money is called operating capital.
Operating expenses: The normal day-to-day expenses involved in running your business, such as rent, payroll, marketing, etc. Operating expenses do not include the cost of your inventory. Large equipment purchases over $500 may be considered capital costs for accounting purposes instead of a normal operating expense.
Profit and loss statement: Often abbreviated P&L. A chart showing net sales, cost of sales, expenses, and net profit over a set time period.
Return on investment (ROI): The profit or return realized from an investment. If you invest $1000 in a bank savings account paying 5% interest per year, your yearly ROI is 5%. If you invest $50,000 to start your business and make a net profit (over a reasonable owner/manager salary) of $3,000 each year, your yearly ROI is 6%.
Startup capital: The amount of money you will need to start your business and keep it operating until the break-even point has been reached. This usually consists of startup costs, 3-6 months operating capital, and enough capital to cover your losses until the break-even point has been reached.
Startup costs: For accounting purposes, startup costs are usually one-time costs for equipment, inventory, buildout, etc. that the business incurs before it opens for operation. These costs are lumped together and then deducted over time (i.e., amortized) rather than being expensed against your company's first year of income. Startup costs make up a portion of the startup capital you will need, but not the entire amount.
If you have any comments or questions about this article please email me at email@example.com. Stay tuned for more articles addressing your bookstore startup concerns. Next up: Naming Your Business!
Questions or comments?