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David Geller

David Geller: Costly Mistake

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Understanding ‘cost of goods’ is key to determining the health of your business, says David Geller.

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[h3]Costly Mistake[/h3]

[dropcap cap=W]hat really is “cost of goods?” Most jewelers think “cost of goods” is the checks you write for product. Nope. If you are writing checks for products and calling it “cost of goods,” you’ll never know how your business is doing.[/dropcap]

So let’s get it straight — cost of goods is not the checks you write. It’s the cost of the item after you’ve sold it.

[inset side=right]Many, many jewelers set up their own books, and do it wrong.[/inset]

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In my job, I see a lot of people’s accounting systems. Many, many jewelers set up their own books, and do it wrong. Then their accountants continue to work around a stupid set of books. But just because an accountant thinks they can right mistakes, I don’t think it will be “very right”. To get it “very right”, you need a real computerized point-of-sales system.  

So, let’s restart the lesson: Your gross profit is the sales made today minus the cost of that object and the cost is located somewhere on the tag (at least it should be).

Inventory is never a cost. Inventory is an investment in your business. And it’s an investment that magically changes into a cost of goods on the day it sells — not the day you send a check to your vendor.

Here’s the wrong way, and we’ll show you why it’s wrong:

In January, I buy 10 Omega chains from ABC Chain Company. Cost $200 each, and we will sell them for $500 each. And let’s say it came in C.O.D. So that means in January, I paid $2,000 for chains (10 x $200 = $2,000).

So those of you who wrote the check as part of your “cost of goods” account would have in January a cost of goods of $2,000. (By the way, whether your account is called “purchases” or “cost of goods” is irrelevant. Many accountants setup a cost of goods account and call it “purchases”. Different name, same animal.)

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Now let’s say you have no sales during January, but on January 31, two people finally come in and each buys an Omega chain.

So what are your sales for January? They’re $1,000 (2 x $500 = $1,000).

And what is your cost of goods for January? It’s $2,000. That means that, according to your P&L, you lost $1,000.  

Is this correct? On your books, it looks correct. But it’s not, and here’s why:

The right way to do it would be to write a C.O.D. check in January for $2,000 for 10 Omega chains. This does not go into cost of goods (or “purchases”), but into an asset account called “inventory”.

[inset side=left]This is correct accounting. It does more than merely tell you your net profit.[/inset]

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That means, you have no cost of goods because it’s an inventory asset. As for the two chains that you sold at $500 each, you now move them out of inventory and into the cost of goods account. This move lowers inventory by $400 ($200 x 2 = $400), leaving your levels at $1,600. Cost of goods has increased to $400 on the P&L.

This way, three accounts are affected: “sales”, cost of goods, and inventory. In the first, you only affected two: sales and cost of goods.

So, if we sold two chains for $1,000 and our cost of those goods is $400, this leaves us with a gross profit of $600. Divide the $600 by the sales of $1,000 and you get your gross profit margin, which is 60 percent.

(One other note: your P&L’s should also have separate columns for all the other big expense categories — salaries, advertising expenses, rent, and the most overlooked category, shrinkage, which tells you how much people stole or destroyed in your store.)

This is correct accounting. It does more than merely tell you your net profit. Really, that figure is only useful to send to Uncle Sam at tax time. This system truly tells you how well you are doing — or how poorly you are doing. It gives you figures each month that you can act upon and adjust to improve your bottom line.

Neither does the old accounting method help you determine your turn; it’s always off and makes you look better than you really are.

Besides, the old method only shows your profit 12 months later, when you take inventory.  

Wouldn’t you rather know today that last month stunk and do something about it to reverse your financial fortune in the coming 30 days? Or, would you prefer to wait until 13 months later when the accountant shows up? What in the world can you do to stem the tide of bad business 13 months later? The answer is … not a whole heckuva lot.  

Hey folks, if you don’t have a real point-of-sale system and you don’t have the accounting setup right, you’ll probably always be robbing Peter to pay Paul.

There are some jewelers who can make a great living without a POS system, but these are people who are completely tuned into their inventory levels and are frugal by nature. And these are few. This is the kind of stuff I regularly tackle when I do store visits.

The big stores all do it the way I described, not the “old accounting way”. By forking over several grand for a new POS system, you can run your store like a big store. Shouldn’t you?

David Geller is an author and consultant to jewelry-store owners on store management and profitability. E-mail him at [email protected].

[span class=note]This story is from the April 2004 edition of INSTORE[/span]

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