Businesses must pay expenses, known as overheads, which can consume all income and drive a company into debt. Tracking gross and net income is important for setting prices and reducing costs. Overhead costs vary and can be classified by accounting methods.
A business may receive a sum of money, but it’s not likely that all of it can be counted as a profit. This is because a business is generally required to pay the expenses. Such expenses are commonly referred to as overheads. Examples of this type of cost include salaries, maintenance, and manufacturing expenses.
It is common for businesses to track their net and gross income. This is important because these figures represent two different values. Gross income refers to all the money a business takes in. This figure can be very large.
Some companies have a wide range of expenses to pay, while others have only a few expenses. Either way, nearly every business will have at least some overhead. Net income refers to the amount of money that is left over after those costs have been deducted.
This amount can be significantly less and may not exist at all. This is because it is possible for a business to have overhead costs that consume all of its income. In some cases, a company’s expenses can even drive them into debt.
Without calculating overhead costs, a business cannot know exactly how much it earns. If ABC Toys purchases its merchandise from a factory, some of the money it receives from the merchandise must be used to not only buy more merchandise, but also pay for items such as electricity, transportation, and wages. Even if ABC Toys manufactures its own merchandise, there will still be costs such as the purchase of machinery and raw materials.
How overhead is classified depends on a company’s accounting methods. Some companies are very basic in determining their expenses. Other companies, however, have very complex methods that may require various departments to access their overhead costs individually. Some companies access them by category. For example, manufacturers can calculate manufacturing expenses and non-manufacturing expenses separately.
Awareness of overhead costs is important for more than just knowing how much profit is being made. These figures often play an important role in a company’s competitiveness. A company generally needs to know what its expenses are when setting prices. Businesses with a lot of overhead are usually forced to charge higher prices than those with less overhead. Therefore, knowing how much expenses are able to allow strategies to reduce these costs.
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