The main aim of starting a business is to make profits. Profits are classified under the broader category of revenues or incomes. Income refers to all the money that a business receives as a result of directly offering its products and services, or through other means that are not connected to the day-to-day operations of a business. This explains why the word income is often used interchangeably with profits.
In order to calculate the total income/net income your business realizes, you would need to determine the total revenues and total expenses. Then, you subtract total expenses from total revenues. A positive figure means the business has made profits while a negative figure denotes losses.
Types Of Income – direct and indirect income and expenses
Business incomes are divided into two broader categories namely direct income and indirect income.
Direct income refers to the income that a business earns through activities that are directly related to the day-to-day operations of the business. On the other hand, indirect income is the revenue that a business generates through channels that are not directly related to its day-to-day operations.
If you run a coffee shop, you probably have a manager, employees and suppliers. The profits you get directly from the sale of coffee, snacks and other beverages in such a store constitutes direct income. Therefore, direct income can be termed active income generated by a business. This explains why any shrewd businessperson will easily tell when there are drastic changes in their direct income patterns. For instance, if your coffee shop generates around $800 per month worth of direct income, and this figure happens to drop to $400 in a given month, you will automatically know something is amiss.
Therefore, direct expenses are easy to track because the entire business depends on them. If your coffee shop was to register a loss in a given month, you would adopt all manner of drastic measures to bring it back to profit-making. This is because if direct income is not well-tracked, your business could easily collapse. And remember, whether your business performs well or dismally, you would still need to pay rent, pay your employees, suppliers as well as renew all municipality licenses. In essence, direct incomes are very important for the existence of a business, so much that a little lapse could cause the business to head south.
What is indirect income ?
Now, on the same coffee shop, you probably have newspapers, old cutlery you no longer use, bottles and cans etc. You may decide to keep them or dispose of them. Usually, many businesses would not worry about disposing of old newspapers until they have made heaps in their offices and are consuming space unduly. Of course, a businessman will not just discard them. Instead, he will assess their value and then put them up for sale. The kind of revenue generated this way is what constitutes indirect incomes.
Evidently, indirect income is not something your business needs to operate. You can consider it an extra stream of cash, or better yet, passive income. However, indirect income has a way of salvaging a business that is in dire straits. For instance, it would be unreasonable to sit back and watch your business make losses when you have a whole carton of cutlery you don’t use, or an old delivery cart that is just lying around.
How To Calculate Direct and Indirect Income
In order to determine your direct income, you need to know about all the elements that constitute expenses. Expenses can be very broad and if not tracked, you might be losing so much money through loopholes that you could easily have avoided. If you are a coffees shop owner, the biggest expenses you probably incur include the purchase and maintenance of equipment such as coffee makers, coffee grinders, Espresso machines, refrigerators, ovens, toasters and other relevant utensils. And even if you already have these in place, there are beverage supplies you will need to pay for from time to time, as well as pay your employees and renew all municipality licenses. Expenses can be very diverse but when it comes to revenue, the channels may be fewer. So, after determining your total expenses, you expect to realize profits out of the sales made on coffee drinks and snacks. The difference between sales made and expenses incurred over a given period of time is what constitutes your direct income. If the difference is positive, then you have made profits and if the difference is negative, that means you made losses. When it comes to indirect income, the formula is more or less the same. However, the difference is the fact that there are probably fewer expenditures. This is for the simple reason that that very expenditure might have already been factored in somewhere when calculating your direct income.
For instance, if you buy a newspaper today and sell it 2 years later as part of a bundle, the initial expenses incurred in purchasing the newspaper must have already been considered at an earlier date when determining your direct income. So, normally, indirect incomes do not involve lots of lengthy computations. Usually, there is only the transportation cost depending on where you are planning to locate the buyer.
Why Should I Care About Both Incomes?
We have already determined that every business owner should keep track of their direct incomes. In fact, this comes naturally. However, not very many entrepreneurs are so successful when it comes to tracking their indirect incomes. This does not mean you shouldn’t. Indirect incomes are just as significant to the operations of your business as direct incomes are. First, it is a way of gaining full value for your money. Though you will often sell the asset at a relatively lower price than the initial purchase price, it is way better than tucking it into the trash. Also, putting up old assets for sale is a way of proving to your employees that you are in charge of your company’s inventory. No business is immune to pilferage, and as you know, employees will often target the least-utilized stuff. But when they occasionally see you selling them, [or just moving them], they will resist all temptations to pilfer.
Also, as we mentioned earlier, indirect incomes can really salvage your business. The revenue earned will come in handy when you are deep in debt or have outstanding payments.
Lastly, it is important to remember that indirect income needs not only be proceeds from the sale of old assets. There are other areas as well, such as offering consultancy services in your line of work and charging for it, starting and monetizing a blog about your company or industry, etc.
And there goes our detailed analysis of direct and indirect income. We hope you will find it useful, especially if you are a startup struggling with keeping tabs of your incomes, expenses and assets.