How to figure profit; a comprehensive reference book for business men, teachers and students

Front matter

A Comprehensive Reference Book

for

Business Men, Teachers and Students

Foreword

How The Idea Came To Me

The idea of figuring profit on sale rather than on cost, as arithmetics universally have been and are still very generally teaching it, came to me thru practical business and accountancy experience and personal contact with successful business men, to whom I feel indebted for the many courtesies extended me.

My Teaching — My Practice — My Books

For years past I have been teaching my students to figure profit on sale and have been applying the same principle in my accountancy practice.

The Cleary System of Business, Bookkeeping, Accounting and Auditing, widely used in the public schools and colleges, teaches the same idea, not as a theory, but as a basic principle of business.

Unconsciously They Developed The Book

But for my students, with whom I have been in close touch, and for the business men whose clubs and associations it has been my privilege to address from time to time, this book would not have been written.

They have been not only an inspiration and an impelling force to me, but they have opened the way for study, investigation and research as it would not have been opened had my work been confined alone to teaching or to business or to accountancy.

A Profitable Experience

Fortunately, too, my classroom experience has been with subject matter ranging from the simplest elements of bookkeeping to the most advanced stages of manufacturing and mercantile cost, and with students ranging in age from eighteen to fifty years and in education from that obtained in the rural school to that obtained in the high school, in the college and in the university and in experience from that of mere casual touch with life to years in the store, in the office and in teaching.

Set Them Right in Figuring

Addressing business men^s clubs and associations has given me an opportunity to get firsthand, at close range and thru informal discussions the methods employed by different persons in the same line and in different lines. I know therefore the practices of most business men in most lines of business. I know also their needs and am sure that the points brought out and developed in succeeding chapters will set them right in figuring profit.

P. Roger Cleary

Ypsilanti, Michigan June, 1918

PART ONE Principles of Correct Figuring

I

Introduction 31- 33

Mission of This Book 31

It Will Benefit Three Classes 31

Value of the General Information 31

The Completeness of the Discussion Will be Appreciated . 32

Their Success is Proof 32

All Will Come to It 33

II The Basis of Figuring is Wrong 34- 37

Not Strange 34

The Principle New Even to Business Men 34

The Arithmetic Idea 35

The Business Idea 35

Distinguish Between Cost and Expense 36

It Does Make a Difference 36

We Cannot Get Around It 37

III Cost and Expense Defined, Differentiated and Statistically Grouped 38- 58

Cost 38

Different Viewpoints of Cost 39

That of The Person Using The Term 40

The Consumer 40

The Retailer or Wholesaler or Jobber 40

The Manufacturer , 40

The Non-Trader 41

That of The Business 41

That of The Stage of Progress 41

That of The Use in a Particular Stage of Progress . . 42

That of The Business and The Investor 42

That of The Bookkeeper and The Accountant ... 43

Expense 44

Divisions and Subdivisions of Expense 45

Statistical or Statement Divisions of Expense ... 51

Divisions of Cost 52

Statistical or Statement Divisions of Cost 54

The Basis of Cost 55

Use and Apply Expense Terms Correctly 56

IV Cost Analysis of Manufacturing and Mercantile Businesses 59- 69

Figure 1 Explained 64

Mercantile , 66

Divisions 67

V

Confusion of Cost Elements Must be Avoided . . . 70- 71

VI Raw Material and Finished Product Differentiated . 72-73

VII

Some Conditions Which Affect Cost and Profit . . 74- 77

The Middleman 74

Contents

P*VGES

In Theory 74

In Practice 75

PART TWO Application of the Principles of Correct Figuring to Your Business

XXII

General to Manufacturing and Merchandising . . . 191-200

Business Defined 191

The Principles Apply to All Businesses 192

Study Other Businesses as Well as Yours 192

Certain Businesses Not Easily Identified 195

The Charting of Your Expenses 196

XXIII A Working Outline for a Manufacturing Business . . 201-212

The Same General Principles Govern 201

Cost Basis 202

A Simple System of Cost Keeping 203

Information Your Cost System Should Give You . . . 203 Statement I:

Cost of Analysis of a Year's Business .... 205 Statement II:

Profit Analysis of a Year's Business 206

Statement III:

Percentage Analysis of a Year's Business . ... . 207

Expense Charts 209

Commercial 210

Direct 211

Statistical 211

Cost Grouping 211

XXIV A Working Outline for a Trading Business . ... 213-234

Expense Charts 213

Carrying Expense . . . *. 213

Merchandise Deductions 214

Operating Expense 214

Direct Expense 215

Statistical 215

Cost Grouping 215

Treatment of Carrying Expense 218

Treatment of Merchandise Deductions 220

Operating Expenses 221

Direct Expenses 222

The Selling or Marked-Up Price 222

What the Gross Profit is Expected to Cover .... 223

Getting Down to Actual Figures 224

Movement of the Stock the Real Test 226

The Week's Average 226

The Estimated and The Actual Profits 227

Correct Stockkeeping Necessary to Correct Figuring . . 228

Inventory Your Stock 228

Merchandise Books 229

The Second Week's Operations 233

The Month's Operations 233

Take a Monthly Statement 233

Inventory at Selling Price 234

XXV Expense Charts for a Non-Trading Business . . . 235-237

Revenue Business 235

Mutual Business 235

Expense Chart 236

XXVI Treatment of Certain Expense Accounts .... 238-256

Rent of Building 238

Proprietorship Salary or Salaries 239

Depreciation 239

Bad Accounts 241

Interest on Borrowed Capital 244

For Current Needs 244

For Construction Purposes 247

Interest Not an Operating Expense 249

PART THREE By Way of Suggestion

XXVII

A Bookkeeping System 259-262

Single Entry 259

Double Entry — Cost System 260

XXVIII

Mutual Understanding 263-265

Educate the Public 263

A Word to the Consumer 264

Charts and Diagrams

TITLE

PAGE

1 Grouping of Costs in a Manufacturing Business . 63

2 Grouping of Costs in a Mercantile Business . . 65

3 Prime or Manufacturing Cost, Gross Profit, Loss

and Selling and Sale Prices Illustrated . Facing 110

4 Price Lot Method of Figuring Profit . . . .164

5 Sales Analysis Chart — Cash Business . . . .174

6 Sales Analysis Chart — Credit Business . . .185

7 Merchandise Summary Facing 232

DIVISIONS

Introduction

Mission of This Book

It is not exactly the mission of this book to teach the business man how to systematize his business, but rather to teach him how to figure profit under the varying conditions which arise in business. Business organization, business system, business management, etc., are subjects too big to be included under this head, but so closely related to it as at least to make their consideration necessary to a proper development of the subject of "How to Figure Profit".

It Will Benefit Three Classes

And, although this book is written from the standpoint of the business man and primarily for his use, the information given will be of no less value to the teacher who is preparing the business men and women of the future, or to the student who is soon to take up the duties and responsibilities of an active business career.

Value of the General Information

It is these three classes that this book is intended to reach and to set right in figuring profit.

I Hozv to Figure Profit

The vast amount of general business information outside, yet directly related to, the subject under consideration is designed to lead the reader to an intelligent understanding of the correct principles of figuring profit and to furnish conclusive proof of the soundness of the principles advocated. This information will be of real value to the business man, to the teacher and to the student in learning how to use the ''key'^ to business success.

The Completeness of The Discussion Will be Appreciated

The bare facts might be stated in a paragraph, and they would be understood by those who are now applying the principles; but those not skilled in accountancy or in the practical side of business need to be shown, and they will appreciate the fullness and completeness of the discussion of the subject under the various related heads in succeeding chapters.

Their Success is Proof

In writing this book, the author is aware that only the most successful business men are fully educated to the idea of figuring profit on sale. But the phrase ''successful business men" furn-

Introduction I

ishes all the evidence necessary as to the soundness of the idea. If the idea were not good, successful business men would not use it; but the fact that they do use it is, in itself, proof that the idea is right, as, otherwise, they would not be successful.

AU Wai Come to It

The author is also aware that this book will go into the hands of many who will not at first agree with him, but before they put the book aside they will. Business men certainly will, and teachers and students will come to it, just as they have come to believe other important facts. It is necessary only to understand the practical side of business to see and appreciate what the application of the principles herein advocated means to the business man.

II

The Basis of Figuring is Wrong

Not Strange

It may seem strange that arithmetics have taught and, for the most part, are still teaching us to figure profit on cost. It may seem strange that the writers of arithmetics have not before this conceived the idea of figuring profit on sale, as successful business men figure it. It may seem strange that they have not seen the successful business man's viewpoint; and, when I say successful business man, I mean the man who has made a sufiicient study of business and business system and administration to figure correctly and thru this to build up a large business.

The Principle New Even to Business Men

But it must not be forgotten that it is only within recent years that business men themselves began to figure in this way, and it is not altogether strange that arithmetic writers and teachers generally should not have gotten hold of the idea

The Basis of Figuring is Wrong II

sooner. But they must come to it. Modern business practice demands it.

The Arithmetic Idea

With few exceptions, the arithmetics tell us to add to cost the per cent of profit we desire to make and we shall have the selling price, the cost representing 100% and the selling price such per cent above as the profit desired represents.

For example, on a hat costing $2 the merchant desires to make a profit of 25%. The arithmetic tells him to add 25% to the cost and he will have a selling price that will yield him a profit of 25%.

Far from it. This sort of figuring has misled, if not absolutely sent to the wall, thousands of business men.

The Business Idea

Those who figure and teach in this way do not see that it is in the selling that the expense of doing business is incurred and that it is on the selling price that the expense must be figured, not on the cost price. If you buy no goods, you will incur no expense in relation to them. But, the minute you start the purchase order, the expense

II Hozv to Figure Profit

begins and it continues until you deliver the article to your customer.. In other words, the expense involved is between the point of purchase (the price you pay for the article) and your customer (the price you receive for the article).

Distinguish Between Cost and Expense

Here, a distinction must be made between cost and expense, looking at the matter from a business and an accountancy point of view. Cost, of course, has different meanings; but for the purpose of this chapter, it means, in a mercantile business, the price paid at the place of purchase. All other outlay in relation to the article which is bought and sold we call expense, and this expense must be met in selling the article ; that is, we must sell the article at a price that will cover this expense, as well as the purchase price, and a little more, as we shall later see.

It Does Make a Difference

So far as the net results are concerned, it may seem to the reader that it would make no difference whether we figure on cost or on sale, provided we figure correctly, provided we know the

The Basis of Figuring is Wrong II

basis of our figuring and know what we are doing in taking what we take as the basis; provided we know that a certain per cent added to a smaller number (cost) is not the same per cent of a larger number (sale), provided we know the exact cost of the goods sold, and provided, further, we wish to make enough simply to cover the expense of doing business, eliminating the net margin to which every business man is entitled.

We Cannot Get Around It

But there are too many things to oe overcome; and, while it may be possible to overcome them in part, yet, no matter how we look at it, in order to add a per cent to cost which will produce a certain profit, we must first figure on sale; we cannot get around it, as we shall later see.

Ill

Cost and Expense Defined, Differentiated

and Statistically Grouped

Cost

Not Understood, Hence Not Correctly Applied — Cost IS not easily defined, since it has different shades of meaning, depending upon how it is used and the purpose for which it is used. To one person it may mean one thing, whereas to another person it may mean quite another thing; yet, to each, the meaning may be not only clear, but correct from his viewpoint.

Generally speaking, however, the term, as used by the masses, while it may seem to be clear, is not. That is, different persons using the term do not comprehend its meaning in the same light or apply it always in the same way; and, as a result, they do not all figure correctly and then they wonder why it is there should be a difference in results under seemingly like conditions.

Explanation of the Term — In general terms, Cost is applied to the price to us of the finished article, or to the price plus additional outlay, which may be a single item or a group of items or the sum of two or more groups of items. It is comprehensible, in other words, in the light of price or of outlay by stages; that is, it has to do with the money value or the outlay at a given point or stage; as, in a retail business, at the point of purchase (Prime Cost), or at the point of delivery (Delivered Cost), or at the point of sale (Subtotal Cost), and similarly in a manufacturing business.

Different Viewpoints of Cost

To different persons, and in different businesses, and in different stages of the same business, and in different uses in each stage, cost has different meanings. Therefore, to apply the term correctly, we must consider it (1) from the viewpoint of the person using the term, or (2) from the viewpoint of the business to which we wish to apply it, or (3) from the viewpoint of the stage of progress in that particular business, or (4) from the viewpoint of the use in the particular stage to which it is to be applied, or (5) from the viewpoint of the business and the one or ones investing in the business, or (6) from the viewpoint of the bookkeeper and accountant.

That of the Person Using the Term

1. From the Viewpoint of the Person Using the Term, Cost means:

a. To the Consumer, usually, the price paid at the place of purchase.

b. To the Retailer or Wholesaler or Jobber, ( 1 ) the price paid at the place of purchase, known, in terms of accountancy, as Prime Cost; or (2) Prime Cost plus the expense involved in bringing the article or articles from the place of purchase to the place of sale, known as Delivered Cost; or (3) Delivered Cost plus the expense involved in effecting the sale and the delivery of the article or articles to the purchaser, known as Subtotal Cost; or (4) Subtotal Cost plus certain additional expense (interest allowed, especially), known as Total Cost.

c. To the Manufacturer, (1) the price paid for material and direct labor, known as Prime Cost; or (2) Prime Cost plus the expense involved in converting the material into salable product, known as Manufacturing Cost; or (3) Manufacturing Cost plus the expense involved in delivering the article to the purchaser, known as Subtotal Cost; or (4) Subtotal Cost plus certain additional expense, known as Total Cost, as in a mercantile business.

d. To the Non-Trader, simply what it costs him to conduct or carry on his business, although in different businesses of this nature there must necessarily be different cost groups, depending upon the business. The lines are too varied to be taken up in detail here.

That of the Business

2. From the Viewpoint of the Bvtsiness, Cost may mean one thing in a retail, wholesale or jobbing business, another in a manufacturing business and still another in a non-trading business. That is, the basis of cost is not the same in these different businesses; it is not expressed in the same terms or made up of the same elements. Therefore, we do not figure it in the same way or, necessarily, from the same basis in businesses of different kinds or always in different businesses of the same kind, since the conditions are not the same.

That of the Stage of Progress

3. From the Viewpoint of the Stage of Progress (cost grouping), Cost in any one business at a particular stage may not be made up of the same elements as in another business at the same or at a corresponding stage; that is, we may have to

Al take into consideration elements of cost in one which do not enter into another; or we may have to group differently. In other words, there is no set chart or outline which can be followed in the same or in a similar stage of progress in all businesses of the same kind or of different kinds.

That of the Use in a Particular Stage OF Progress

4. From the Viewpoint of the Use in a Particular Stage of Progress, Cost must be differently considered. For example, in a manufacturing business, in the factory stage, certain material may go into the manufacture of a certain article; again, some of the same material may go into the repair of certain equipment necessary to produce this article; while, again, the piece of equipment may become valueless and must be replaced by new from this material.

The same material is applied to these three uses, yet different cost elements and cost groups are affected by the three different uses to which the material is applied.

That of the Business and the Investor

5. From the Viewpoint of the Business or Venture and that of the One or Ones Investing in the Business or Venture, Cost must be differently considered. For example :

From the viewpoint of the business, ledger costs or charges only can be taken into consideration in the classification or statistical arrangement of the statement.

But, from the viewpoint of the investor, an additional charge or deduction (from earnings) should be made in the statement (only) for Interest on Investment, and the statement which does not take this into consideration is not complete, whether viewed from the standpoint of accountancy or good business, as we shall later see.

The cost to the business is the outlay and the compensation for this is the earnings, the difference being Nominal Net Earnings or Profit.

The cost to the investor is the forfeiture of the interest on the amount which he invests, looking at the matter from the viewpoint of what it would bring if on secured loan, and the compensation to him for this is the Nominal Net Earnings from the capital invested as shown by the statement, the difference (between the interest and the earnings) representing a gain or a loss over placing his money on secured loan.

That of the Bookkeeper and the Accountant 6. From the Viewpoint of the Bookkeeper and the Accountant, Cost is closely related to Charge, but it does not necessarily mean the same. For example :

a. To the Bookkeeper, Cost suggests a charge to some particular account.

b. To the Accountant, Cost suggests a charge not only to a particular account, but to a particular group, or class, or section, or division, of accounts; and this not only as applied to the ledger, but to the monthly and yearly statements as well.

In other words. Cost Charging for record is one thing; Cost Grouping for statistical or statement purposes is another. Both are important and necessary to correct figuring and the enlightenment of those financially interested.

Expense

Distinguished From Cost — The term Expense, as distinguished from Cost, comprehends the individual items of outlay entering into or which go to increase or to make up each cost group — the item or group of items which supplements, adds to or increases the price (Prime Cost) or any distinct or definite cost group or total following the price.

For example, at the place of purchase the Prime Cost of an article or group of articles may be

$50, which would constitute the first cost. The additional outlay in bringing the article or articles from the place of purchase to the place of sale amounts to, say, $1.05, $0.80 being for freight and $0.25 for cartage. This outlay we call Expense, since it supplements, adds to or increases the first cost. The first cost (Prime) and these two items of Expense, therefore, while they remain detached, retain their distinction or individuality as Cost and Expense, respectively; but the minute they are grouped together or merged to form a second or new cost basis to be increased by additional expense outlay of another nature, they lose their individual identity and become known simply as Cost under an appropriate title, as Merchandise or Delivered Cost. To this cost (total to this point) are added items of outlay or expense entering into another group bearing another title or name. And so on, the Expense increases and the Cost accumulates until the end (Total Cost) is reached thru the different stages of cost grouping into which the total outlay or charge is divided in the conduct 6f a business of whatever kind or nature.

Divisions and Subdivisions of Expense Two Classifications — In mercantile, manufacturing and most other businesses, the items of outlay or charge or deduction which we call expense may be divided into two general divisions, namely, Indirect, which means to charge indirectly or thru other accounts to Capital Earnings, and Direct, which means to charge directly to Capital Earnings. Or these items may be divided into three divisions, namely. Carrying or Manufacturing, Operating or Commercial and Direct. This analysis implies that Indirect expenses may be subdivided into Carrying or Manufacturing and Operating or Commercial — Carrying and Operating in a mercantile business and Manufacturing and Commercial in a manufacturing business.

Carrying Expense — Carrying expense or charge in a mercantile business represents the items of outlay which add to or increase the purchase price, which add to the cost (Prime) or asset value of the merchandise delivered to us. And by some this is taken as the basis of cost, rather than the purchase price, and may be so taken under certain methods of figuring and cost keeping, but not as most retail merchants figure or reckon cost. The exact expense involved (and no more) should be added to the invoice price.

Expense Follows the Cost Basis — If price is taken as the basis of cost, all additional outlay in han-

Cost and Expense Defined . Ill

dling the merchanidise (including Carrying Expense if so treated) is Indirect expense, but not necessarily Operating expense. A distinction, in this case, must be made in using these two terms: that is, they should not be used interchangeably.

Indirect Expense — Since Prime Cost is taken as the basis by the author, the term Operating as distinguished from Carrying will be used rather than Indirect. It will not be out of place, however, to state that Indirect expenses or charges represent items of expense which are deductible from Capital Earnings indirectly, that is, thru accounts which are necessary to the running of the business, regardless of capitalization or how conducted, and which in themselves form a group charge to be added to a previous Group Total for the purpose of forming a new and increased Cost Basis or Cost Total. In other words, they represent items of expense which are common to all businesses of a kind or class.

Or, again, it may be stated that expenses are close, near, vital, to the operations of, or intimately related to, a business (Indirect) or that they are more or less remote or removed (Direct), such as interest allowed, which, in this case, is the result of operating on limited capital.

Or, from another viewpoint, it may be stated that Indirect expenses are items of ledger cost or charge which find their way to Loss and Gain thru such accounts as Fuel, Light, Taxes, Insurance and similar accounts which are periodically closed to Loss and Gain.

The Natural Divisions — The expense involved in the conduct of a mercantile business whose basis of cost is the purchase price may be divided, as above, into three distinct divisions, namely. Carrying, Operating and Direct. And it is important that the line be clearly drawn between these divisions. While the first is an element of expense, yet it is also an element of merchandise cost. In the light or sense of asset value, it bears the same relation to merchandise cost that price does. These two elements, Purchase Price and Carrying Expense, therefore constitute merchandise cost or delivered cost, as you choose to call it.

Operating Expense — The operating expense, the outlay involved in the regular course or conduct of the business, begins (except as preceded by purchasing expense) at the point of receiving the goods from the carrier; in other words, at the receiving room. It represents the items of expense involved in converting the merchandise into cash.

Purchase price and carrying expense are two items of cost and expense, respectively, which are common to all mercantile businesses. Revenue is not possible in any business without these two items. They represent asset value and, together, can be turned into money.

It will be noted, therefore, that Carrying (if made a ledger charge) and Operating expenses together mean the same as Indirect expenses; that is, they are subdivisions of Indirect expense.

Direct Expenses — Direct expenses, on the other hand, are items of charge which are not incident to the business, which the business, as a venture, as a going concern, does not require or call for, but which the management, in a sense, forces upon it. And, since they are the result of insufficient capitalization (interest allowed, etc.), it would not be fair to the earning capacity or power of the business to include them with the operating or running expenses; in other words, to carry them as operating accounts; and, therefore, they are made a direct charge to Earnings — posted directly to Loss and Gain — or made a separate group by themselves (which is the better way) in the Ledger and in the Statement and independently charged, thru Loss and Gain, to Capital Earnings. They are made a charge group distinct from the Operating expenses in order to determine what the business, under favorable conditions or, in comparison with other businesses of a Hke nature, is capable of producing.

Direct expenses are incurred, then, because of certain conditions which exist in certain businesses, but which do not exist in certain other businesses of the same kind or class as do Operating expenses.

In a mercantile business, therefore. Indirect expenses or charges are subdivided into Carrying (if made a ledger charge) and Operating (or Commercial, which means the same) ; and, in a manufacturing business, into Manufacturing and Commercial.

What Carrying Expenses Include — Carrying expenses (Freight, Express, Cartage and Parcel Post — In) represent the expense incurred between Prime Cost and Delivered Cost and form a distinct cost group (part of merchandise cost), bearing no more relation to operating expenses than do Direct Charges. These two groups of expenses (Carrying and Direct) should be kept separate and apart from the operating expenses in a mercantile business.

Operating Expenses in Three Divisions — Operating or Commercial expenses in mercantile businesses may be subdivided into Purchasing, Administrative and Selling. They represent the expenses incurred between Delivered Cost and Subtotal Cost.

In manufacturing businesses, there may be two divisions of expense following Manufacturing Cost, namely, Administrative and Selling — not including Direct Charges; that is. Commercial Expenses may be so divided or subdivided.

Expense Grouping — Dividing and subdividing expenses in this way we call Expense Grouping, each group representing a distinct element of charge or cost to be added to a preceding division of Cost, as where Carrying expenses are added to Prime Cost to get Merchandise or Delivered Cost; Operating or Commercial expenses to Delivered Cost to get Operating or Subtotal Cost, and Direct Charges to Subtotal Cost to get Total Cost.