 of the inventory that is in essence being expensed. So businesses that sell products figure your gross profits by first figuring your net receipts figure net receipts line three on schedule C by subtracting any returns and allowances line two from gross receipts line one. So in other words we're looking at the revenue side of things. When we think about the revenue side we could have these returns and allowances which we talked a little bit about in prior presentations meaning if someone returns the inventory that kind of negates the sale that took place. What are you going to do in that case? Are you going to reduce the inventory line item itself? The revenue, the sales line? Not usually because we don't like decreasing the sales line. Instead we create another account not an expense account but it acts like an expense account in that it's going to be up in the revenue kind of section. You might call it a contra revenue account which is going to be a decrease to the sales line to get to basically the net sales line as opposed to net income line right. So returns and allowances include cash or credit refunds you make to customers rebates or other allowances off the actual sales price. So next subtract the cost of goods sold which we talked about in a prior presentation line four from net receipts line three the result is gross profit. That's just the subtotal on the way down the way because the cost of goods sold is such an important number we want to have its own little subtotal category up top. Businesses that sell services you do not have to figure the cost of goods sold if the sale of merchandise is not an income producing factor for your business. So if you're a service business you got no cost of goods sold so the gross profit calculation isn't really a thing so much in that case because you're not dealing with inventory and therefore not cost of goods sold therefore gross profit isn't a thing. Your gross profit is the same as your net receipts gross receipts minus any refunds rebates or other allowances. Most professions and businesses that sell services rather than products can figure gross profit directly from net receipts in this way. In other words you're just going to carry down your sales number to the gross profit as if because there's nothing to subtract from it because there's no cost of goods sold illustration. So this illustration of gross profit section of the income statement of a retail business shows how gross profit is figured. So you got the income statement for a year ended December 31st 2022 you got the gross receipts again they're not really gross that's just your revenue account don't be grossed out by it or anything 400,000 and then you're going to subtract out the returns and allowances people returned the merchandise it negates the gross receipts or the revenues should you just decrease the revenue by that 14940 no should we expense it no we're going to put it up top as a contra revenue account acting kind of like an expense account but we want to break it out up top in the contra revenue that gives us our net receipts is net receipts the same as net income no net income is after all the expenses and whatnot this is net receipts our net sales line up top that comes out to the 38560 minus the cost of goods sold the cost of the inventory the expense of us consuming the inventory to generate the revenue in this case of 288140 that gives us our gross profit of the 96920 so the gross profit is that the same as net income no it's just a pit stop on the way it's only subtracting out one of the expenses the big one the cost of goods sold all the other expenses need to be subtracted out from it before we get to the bottom line of the income statement or the schedule c in essence net income so this is going to be the cost of goods sold calculation we had to calculate the cost of goods sold to get to this number for the cost of goods sold here the 288140 cost of goods sold that's going to be I think on part three of the schedule c where we kind of summarize this cost of goods sold calculation so let's take a look at that that's where we have the beginning inventory inventory should be the same as the ending inventory in the prior year plus purchases how much we purchased for inventory 285900 so the beginning inventory 337845 plus purchases 285900 minus items withdrawn for personal use so we dipped into our own stash and we decreased the inventory by 2006 50 the other side going to draws because it we drove we drove we drew it out for our personal use which is the balance sheet account not on the income statement so that comes out to the 283250 that's the 285900 in the 2006 50 283250 so the 37845 plus the 283250 gives us the goods available for sale throughout the entire year did we have $321,095 in inventory at any given time in the year no that's how much we would have had if we hadn't sold any inventory throughout the entire year we're imaginary number our stock pile of inventory as if the entire year was one point in time and we didn't sell any of it minus the ending inventory the stuff that we didn't sell in dollars measured in dollars 32,955 gives us the cost of goods sold the 288140 which we could see on the income statement helping us to calculate the gross profit there's the 288140 okay so items to check item one check the weather forecast consider the following items before figuring your gross profit gross receipts at the end of each business day make sure your your records balance with your actual cash and credit receipts for the day you may find it helpful to use cash registers to keep track of receipts you should also use a proper invoicing system and keep a separate bank account for your business so depending on the type of business that you have if you sell inventory in a store or something like that having an accounting system like a cash register type of system checking your receipts to to your physical cash and your and the revenue that you've collected those internal controls are useful from a bookkeeping standpoint sales tax collected check to make sure your records show the correct sales tax collection this is getting more into bookkeeping kind of situations we talked a little bit about sales tax in the past if you sell inventory it's likely in the united states that the state and local government may force you to charge sales tax which is in essence supposed to be a tax on the purchase person purchasing the customer not on you the business owner but you are the collection agent and therefore you have to increase the price of your sale by whatever the sales tax is and collect that pay that to the government how are you going to record that well for example if you sold something for ten dollars and you had to charge two dollars of sales tax then you should basically record revenue of ten dollars and the two dollars should be a liability that you have collected and then you're going to pay it to the government reducing the liability and reducing the cash account when you pay it to the government instead of recording twelve dollars as revenue including the sales tax and then having an expense of two dollars you can see the net income would be the same either way you might say what's the difference because because the theory is that it's not really your income you're just the tax collector so you shouldn't have income and expense it should just be an off income statement item accounting software is quite useful to help you to kind of account for that stuff this question does come up if you deal with taxes with people that have to deal with sales tax because when they pay the sales tax they're like hey i need a sales tax expense but if they didn't include the sales tax in revenue which they shouldn't have then then it wouldn't make sense to have the sales tax expense and if they did include the sales tax in revenue you would think that you would need to reduce the revenue to what your actual revenue was because sales tax shouldn't be part of revenue technically okay so if you collect state and local sales taxes imposed on you as the seller of goods or services from the buyer you must include the amount collected in gross receipt if you are required to collect state and local taxes imposed on the buyer and return them over to state or local government you generally do not include these amounts in income one more time if you collect state and local sales tax imposed on you as the seller of goods and services from the buyer you must include the amount collected in gross receipts if you are required to collect state and local taxes imposed on the buyer and turn them over to state or local governments you generally do not include these amounts in income inventory at beginning of year compare this figure with last year's ending inventory the two amounts should usually be the same so when you're checking your income statement to see if there's any kind of red flags or things that should be jumping out at you one thing that should be jumping out of you that you should be double checking is that the beginning inventory you have matches the ending inventory in the prior year if it does not you would need to explain why or it looks like a red flag something they cover