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Reviewing the Cost of Goods Sold (“COGS”) and Gross Profit line items, and the typical distinction between Gross Margin and Gross Profit.
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All right, in this video, we're gonna
talk about the next sections of the P&L,
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cost of goods sold, or
COGS, and gross profit.
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Similar to revenue, sometimes what
companies call COGS will change.
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We can see that Apple
refers to cost of sales.
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Sometimes you'll see cost of revenue or
cost of services.
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As we are introducing concepts, don't get
hung up on why they are named differently.
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The main thing to internalize is that
COGS represents costs that are directly
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associated with the revenue or
sales you earned.
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I'll use an example I've given in other
courses because it's a great example.
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When we buy a cup of coffee,
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the coffee shop is going to incur
some costs specific to that coffee.
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The water and coffee used to brew the
contents of our cup, the actual cup that
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the coffee comes in, and
any milk we take, etc., those are COGS.
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The salary of the barista,
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the rent of the shop, those are generally
not considered COGS because they
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would have happened regardless of
whether we sold the coffee or not.
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Often, these costs not directly related
to the cup of coffee are referred to as,
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quote, overheads.
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They are usually fixed costs.
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COGS are more likely to be variable costs,
but not always.
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So once we subtract our COGS from our
revenue, we are left with gross profit.
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Remember how earlier in the course we
talked about the difference between gross
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revenue and net revenue?
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Well, here's another application of that.
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Gross profit isn't our profit profit.
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It's our profit before other costs that
need to be factored in to get to our
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net profit, which is profit profit.
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I'll elaborate more on
that later in this stage.
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Back to gross profit, though.
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So this is basically the first measure
of profit that shows up on our P&L.
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Gross profit shows the amount
of money we would make
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if we didn't have to do anything
other than make the products we sell.
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Of course, there are a whole lot of other
costs, like rent, and sales, and so forth.
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So just under gross profit,
you'll see gross margin.
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Some people make the mistake of using
these terms interchangeably, but
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that's not best practice.
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Gross profit is the nominal value,
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gross margin is your gross
profit divided by revenue.
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So when you talk about margins on the P&L,
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it's always about a certain
nominal value divided by revenue.
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You'll see more examples
of that in later videos.
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Let's talk about this some more, though.
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Can you think of a situation where
your gross profit goes up, but
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it's not necessarily good news?
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Go ahead and pause the video and
think about it a bit.
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Hi, welcome back.
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So let's say we've doubled
our revenue from 100 to 200.
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Our gross profit went from 50 to 60,
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that means our gross profit
improved by 20% year-on-year.
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But our revenue increased
by 100% year-on-year.
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This means our gross margin
declined from 50% to 30%,
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we had gross margin contraction.
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This would be extremely
alarming to management.
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Ideally, we would like to see our gross
margins staying consistent year in and
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year out, or, better yet, improving.
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Think about the ramifications
of this a bit.
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Depending on the product you're creating
or the service you're providing,
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commodities can have a major impact on
your gross profit and gross margin.
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This is why the price of a barrel of crude
oil is such a closely tracked number,
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because it's a major COGS item for
several industries.
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