The Cost of Sales 2/2

This month we complete this two part series on the cost of sales.

Last month we defined cost of sales as quantifying the cost value of the stock items that you sold in your business. We also recognised that in hair salons there is Retail Stock and Professional Stock.

I think that the bottom line for why cost of sales is so important is because it helps you to determine how much money you can “take to the bank” when you sell Retail and even Service items.

You may sell R100 000 worth of retail stock but this is not profit, ie you didn’t actually make R100 000. You actually made R100 000 less whatever it cost you to acquire the items you sold.

This is a very basic business principle but as discussed last month the problem is how to keep track of the cost value of all the items you sold.

The general formula was to say that whatever you started the month with, plus whatever else you bought throughout the month, less what is left at the month is what was used/sold during the month, ie Opening Stock, Plus Purchases, Less Closing Stock.

What your accountant needs

Generally your accountant will ask you to give them a stock valuation at the end of each month so that they can use this in the above formula (ie Opening/Closing Stock). That is why it is best to do a stock take at least once a month so that the stock valuation you give to your accountant is accurate.

They will also ask you for your stock invoices from your suppliers or for a report from your computer system, which will show them the stock added to your inventory during the month. They generally want this split between retail and professional stock. Then they will use these figures to calculate your cost of sales and give you your gross profit for the month.

Stock Valuation Methods

As mentioned above doing a stock count just before giving your accountant a stock valuation report is best practise as it ensures that the valuation is as accurate as possible. However, this is only as far as the quantities of stock are concerned.

What also needs to be taken into consideration is the method that you use to value the stock. The reason being that if you have 5 particular items on your shelf but you bought 3 of them at R100 and 2 of them at R110 the value of this particular item is actually (3xR100) + (2xR110) = R520. This reason for this situation is because suppliers increase their prices and also give discounts and therefore to get a true reflection of the value of stock you need to take this into consideration. This is where you will here terms like First in First Out (FIFO), Last in First Out (LIFO) and Weighted Average as stock valuation methods.

For these purposes it will depend largely on the capabilities of your salon management software and what type of stock valuation reports it is able to give to you.

Shrinkage

When you do your stock takes you may find discrepancies between what you count and what you should have on hand. After you have double checked that you have counted correctly and verified that no stock is sitting in the reception desk cupboard waiting to be collected by a client etc then you will need to “write off” whatever stock items you cannot account for. Ideally this value should be allocated to a shrinkage account of its own rather than being allocated to cost of sales because you didn’t actually sell the items.

Again, you will depend largely on your salon management software and whether it can provide you with a report for the cost of the items that you are writing off and you should forward this information to your account as well so that they can allocate it accordingly.

Replenishing Stock

A healthy practise is to use your cost of sales figure to budget for what you need to set aside in order to replenish the stock that you have sold. There are few things more revealing about the health of a business than the state of the stock on the shelves. On the same note you also don’t want to over stock your shelves as this can tie up valuable cash resources.

If your salon management software is able then ordering stock based on what you have sold in a particular period is very helpful as this becomes very specific as to exactly which items need to be ordered.

Gross Profit Reporting

Another method for tracking the cost of sales is directly through your salon management software. This would require that whenever an item is sold the cost price of that item is tracked in much the same way as the selling price. This would effectively mean that you would be able to run a report per Supplier, Category, Staff Member or Item and see the details of what has been sold including the Selling Value as well as the Cost Value, resulting in a detailed Gross Profit Report being available immediately.

This is very useful for your accountant to compare this figure to the theoretical value they obtain from the Opening Stock + Purchases – Closing Stock formula. In a perfect world these figures should be the same, any difference being attributed to Shrinkage.

Stock Recipes

The Hair and Beauty industries are very similar in that they both deal with Services, Retail Stock and Professional Stock. What is very different however is that in the Beauty industry it is very common to set up pre-defined Stock Recipes for the different treatments on the price list. For example a Facial would have a recipe of the exact millilitres of Cleanser, Toner and Moisturiser and in theory this is what always should be used when doing a facial. The beauty of this is that if your salon management software has the ability then you can link these recipes to your treatments so that when you sell the treatment the stock levels are automatically adjusted in millilitres and you can also get an exact stock cost for the treatment thus having a detailed Gross Profit report for the services you have sold.

When it comes to hair, however, it is a little more difficult as the recipes would equate generally to colour formulas and the like and will be different for each client. There are instances though where you could say that for every service you perform you wish to automatically deduct a set amount of shampoo and conditioner that is used at the basin. The stock used at the basin can therefore form part of the cost of sales for your services and will bring in a level of theoretical stock control (and costing) for these items.

Thereafter it will vary as to how disciplined your staff are at monitoring what stock they use for each client during the service they perform.

Conclusion

As you can see calculating the cost of sales can be quite complicated and my advice would be to introduce control in layers.

Keep it as simple as possible to start and first get the basics right. Do regular stock takes, ensure that you load all your stock invoices into your computer system, ensure that your stock items have all their cost prices correctly set up and use the process to budget for replenishment of stock sold.

Focus on retail stock to start and get this right before moving on. If you can’t get it right for retail you will never get it right for professional stock. When you do start with professional stock do it slowly and start with “per bottle” control first, then later introduce per millilitre control. Take control one small step at a time. The more efficient you are with your stock control the more accurate your cost of sales will be and the result with be that you have a better idea of how much money you are actually making.