On this blog we’ve often talked about Sellers Discretionary Earnings (SDE.) This is the number that potential buyers look at when evaluating whether they want to make an offer on your business.
But we realize that not every business owner is ready to sell, or even wants to sell. If your primary objective isn’t for investors to see how you measure up against other sellers, but instead to increase profitability and make better business decisions for the futured, we recommend you track another number: post-advertising gross (PAG.)
PAG is a fairly simple equation:
Sales – COGS = Gross Profit
Gross Profit – Advertising = PAG
Once you’ve figured out your PAG, you’ll have a full picture of your business’s financial health, and you’ll be armed with the knowledge of what you need to do if part of your business isn’t as robust as it could be.
Why track PAG?
PAG’s importance is right there in the name: “advertising.” The reason advertising is so important in e-commerce is that it’s the engine that actually drives sales to your business. If you fire your accountant or your customer service agent, you probably won’t notice an immediate drop in sales volume. But if you shut down Amazon PPC, you will see the impact on sales and profitability immediately.
In the e-Commerce world, just tracking how much money is coming into your store is an incomplete picture of your business’s health. To see how profitable your business really is, it’s vital to account for COGS and ad spend.
Let’s take two businesses as an example. We’ll call them Adam’s Aroma Essentials and Bob’s Baseball Bonanza.
Calculating PAG: An Eye-Opening Example
Adam and Bob both show 50% gross profit. (I.e. They sell their product for $100 on Amazon and pay $50 in Amazon fees and COGS.) If Bob and Adam both calculated gross profit and then stopped right there, they might both think that their businesses were doing pretty great.
However, Adam has a gross profit of 50% with an advertising budget of 10%. So, according to the equation above, his PAG would be 40%.
Bob, though, has a gross profit of 50% but his advertising budget is a whopping 35%. This means Bob’s PAG is just 15%.
Now, let’s say that both Adam and Bob make $1mm in sales this year. This is where the difference really stands out.
Adam’s $1mm in sales x .40 PAG leaves him with $400,000 in profit. He can spend that $400,000 on other business overhead, payroll, research & development, and of course his own profit!
Bob’s $1mm in sales x .15 PAG leaves him with just $150,000 to cover all the same expenses. Ouch. It’s beginning to look like Bob is in trouble.
If Adam and Bob had only calculated their gross profit, but not their PAG, they would not have gotten a clear picture of how much money they can really take home at the end of the day. Bob, especially, would have benefitted from a hard look at this PAG because it would have allowed him to isolate the reason – advertising costs – that his businesses isn’t as healthy as it could be.
How to Increase your PAG
If you’ve calculated your PAG and didn’t like the number staring back at you, I get it. First of all, like G.I. Joe says, knowing is half the battle.
We’ve written in-depth here about the Four Levers of Amazon Profitability and I suggest you check out that post. But in a nutshell, to increase Amazon profitability:
- Increase sales
- Increase gross profit margins by decreasing COGS
- Decrease ad spend (by recognizing and killing inefficiency)
- Decrease overhead
Summing up Post-Advertising Gross (PAG)
PAG separates out costs that are directly related to the sales engine of your business. Seller Accountant co-founder Tyler Jefcoat sometimes compares an Amazon business to a car. Figuring out your PAG is like giving your engine (i.e. your sales engine) a good tune-up. Advertising is the fuel that helps the engine run. Without that fuel, your car isn’t going anywhere.
But then there’s the rest of your business. Your overhead, payroll, etc. are all being stored in the trunk of the car. If the load is heavy, your car isn’t going to go very fast. But if you can lighten your load, such as by decreasing COGS and overhead, your aerodynamic vehicle will hum along. In other words, if you want your car to go as fast as possible, optimize the engine and then remove all the unnecessary junk from the trunk. Keeping up with your business’s PAG allows you to do just that.
Do you have questions about calculating your PAG? Need assistance? Sign up for a free e-commerce accounting consultation today.