Accounting for Authors
I’m sure there are very few authors that would claim to enjoy the accounting side of self-publishing. But keeping track of your numbers is essential, because selling copies and getting royalties can make it seem like the money is flowing and the profits are growing, despite the fact that your fixed costs mean you’re actually still in the red.
The whole subject seems daunting, but that’s why we turned to someone that has literally wrote a book on the subject. D.F. Hart’s Accounting for Authors is coming out next month, but today she stopped by to give us a quick little primer, laying out all of the key terms and factors that self-published authors need to think about.
Ah, numbers. Most authors’ least favorite component of self-publishing. They’re necessary – but they don’t have to be painful. Understanding some basic accounting concepts can go a long way toward strengthening your author business.
Because a business is exactly what this is. The moment you assigned your ‘book baby’ a price tag and put it up for sale, you became a published author – and if you independently published your book, you also became a business owner.
Now, I realize that some people do not like numbers and do not like math (confession: I do not like math very much, either!) and there’s a good chance that those people reading this right now have just laid their head down on the closest hard flat surface and are banging it lightly.
I get that, and I feel you. I do. But trust me when I say to you that the health of your business is going to be better served if you at least understand the basics.
While there are a multitude of things we could cover in this post, today I’d like to focus on:
- The ‘Accounting Equation’
- Some common definitions & calculations, specifically:
Assets, Liabilities, Equity, and the “Accounting Equation”
Assets are the things your business OWNS that have value. They can be tangible (in physical form) or intangible (not in physical form).
Tangible assets are things like a building, the money in your bank account and the computer you use to create your stories – anything that is in physical form and can convert to cash quickly. For any paperback books you just stocked up on for an upcoming signing event, whether they are considered ‘inventory’ (tangible asset) or simply expensed depends on whether you are using the accrual-basis method or the cash-basis method.
And I must note that there is one weird exception to the ‘in physical form’ rule.
One tangible asset that every one of us authors have, at this very moment, are outstanding book royalties that have not yet hit our bank accounts. Monies owed to us like this are classed as Accounts Receivables in the accrual-basis method. Now, you would think that since they are technically not in ‘physical form’ that receivables would fall under intangible, but surprisingly, since they are considered ‘cash or cash equivalent’ they do not!
Intangible assets are things like copyrights, patents, trademarks, logos, slogans, and company names.
Liabilities are, quite simply, the things that your business OWES.
The most common examples in the author world would be cover design costs, editing/formatting costs, copyright application fees, printing and shipping costs, narration costs, and so forth. These outbound things that you owe are called Payables. There are other things that fall into the liabilities category, but the majority of them will not apply to most authors’ businesses, so I will not bog you down with them here.
Equity (sometimes also referred to as Capital) is quite simply what your business has left after everything your business OWES has been paid for.
The Accounting Equation
It is very simple-looking, given that it is one of the fundamental cornerstones of accounting. Here it is:
Assets = Liabilities + Equity
Wow, that’s great, D.F., but what does that mean?
So glad you asked. Remember earlier when I talked about assets, liabilities, and equity?
Here they are again, in plain language:
Assets – Things your business OWNS.
Liabilities – Things your business OWES.
Equity – What is left over after the things your business OWES are paid for.
Now, look again at that original Accounting Equation:
Assets = Liabilities + Equity
But this time, plug in the simpler definitions.
What is OWNED = What is OWED + What is left
So now, that Accounting Equation becomes less intimidating, right?
But even in its improved current state, it is still not that helpful for us.
What if we move it around a bit and isolate the part we need? Because if we are being honest, what we are really the most interested in is the ‘what’s left over’ part, right?
Yeppers. So, we spin the equation:
What is left = What is OWNED – what is OWED.
Now we are getting somewhere.
And you might not realize it, but I am willing to bet that you are already using the Accounting Equation somewhere in your day-to-day activities.
- Available balance in your checking account = Current bank balance minus any checks you wrote that have not cleared yet
- Take-home pay from a job = The pay you earned minus taxes taken out
- Book Royalty = The selling price of your book minus the storefront’s percentage
Each one of these examples uses that rearranged Accounting Equation!
Pretty cool, huh?
Let’s Talk Cost
Cost of Sales (aka Cost of Goods Sold) means the money spent to make your product. G&A , or “Overhead” Expenses, means the money spent to run your business and advertise/sell your product.
Costs have distinct characteristics: They can be direct or indirect, and fixed or variable.
- Direct costs – production costs
- Indirect costs – overhead expenses
- Fixed costs – remain constant no matter how much is produced
- Variable costs – changes depending on amount of production
In the author world, a fixed cost example in production is cover design – typically, we pay a one-time flat rate per cover.
A good ‘overhead’ fixed expense example is the annual membership to an author organization.
A good example in the author world of a variable production cost is selling a paperback book. For each book that is sold, you incur another set of printing and shipping costs.
An excellent example of a variable ‘overhead’ expense is marketing: namely, cost-per-click ads.
- Cost-per-click Ads – are a variable indirect expense
- Membership Dues – are a fixed indirect expense
- Cover design – is a fixed direct cost
- Shipping costs for paperbacks – is a variable direct cost
Let’s Talk Profit
The three most important calculations in your arsenal to find out if you are making a profit or not are:
- Break-Even Point (#): The # of sales needed to recoup all your costs and start making a profit
- Gross Income (Gross Profit/Loss) ($): Sales – Direct Costs
- Net Income (Net Profit/Loss) ($): Gross Income – Indirect Costs
Basically, break-even point is the “sweet spot” – the point that you have sold enough of your product to completely recoup your costs. Any sales beyond your break-even point are purely profit.
Gross Income (Profit/Loss)
Gross Income is what you see after you subtract your business’s Cost of Sales from your Sales Revenue.
Another way to look at it is: how much money did I make or lose with my “products” (books)? Are my book sales at least paying for what I spent to make the books happen?
Why this is important: If you can see this, particularly at a ‘per format/title/pen name’ level, it can help you tweak your approach (and how you use your resources) to maximize potential earnings.
- One book, pen name, or series is outperforming another
- That audio/large print/translation is (or isn’t) a good investment for your brand
Net Income goes a step further. Net Income is Sales Revenue minus Cost of Sales minus Operating Expenses. OR, Gross Income minus Operating Expenses.
Net Income (Net Profit/Loss)
Gross Income – Indirect Costs
Another way to look at it is – how much money did I make or lose OVERALL, including my overhead expenses?
Why this is important: We all have expenses that come along with running a business, and these expenses happen whether we sell 10,000 books, or zero. These are the ‘costs of doing business’ or ‘CDB’s’. And if your sales aren’t also covering these expenses, you’re operating at a loss.
Let’s Talk Marketing
Some calculations that will come in handy in your marketing endeavors are:
- CPC ($): Investment / # of clicks
- Cost Per Sale ($): Investment / # of sales
- Net Return ($): Results of activity – Initial cost of activity
- Return on Investment (%): (Net return / Initial cost) x 100 (Also called “ROI”)
- Payback Period (years): Initial cost / First year sales $
Net Return, Return on Investment (ROI) and Payback Period
These three concepts are interrelated.
Net return is what you made (or lost) on an activity after you subtract out the costs of that activity from the results of that activity.
Return on Investment (ROI) is shown as a percentage, and in basic terms, it’s a measurement of how well a certain activity did.
Payback Period simply refers to the length of time that it takes for an investment or activity to reach break-even point, or in other words, how long it takes to recover that cost. Typically, this is measured in years.
A word about Cost-per-Click Ads (CPC): Don’t just look at cost-per-click amount, dig deeper.
For example: $75 spent on a CPC ad to advertise a $4.99 e-book. 125 people click the ‘call to action’ button:
CPC = $75 / 125 = $0.60 per click.
Now, if 35 of the people who clicked went on to buy the book, then:
$75 / 35 = $2.14 cost per sale. (compare this # to your net royalty per book; if it’s lower than your royalty, that’s good, if not, that’s bad.) For example, if you were earning $3.49 in royalties per book:
35 x $3.49 royalty per book = $122.15 in sales.
Net return = $122.15 – $75.00 = $47.15
ROI = $47.15 / $75 = .628 x 100 = 62.8%
Bonus Section: Risk Tolerance and Risk Capacity
While these two terms are more commonly used and seen in the wealth management and financial services sector, I think that they are important for all business owners to know, understand, and remember.
Risk Tolerance, in a nutshell, is the amount of uncertainty (or risk) that you as a business owner are comfortable with.
Risk Capacity is the amount of risk that you must take to reach your goals.
How do these last two terms relate to being an author? Well, let’s talk about my first audiobook as an example.
Was I comfortable with making that investment? Yes, at the time I considered audiobook costs to be within my risk tolerance level.
Was that a risk that I absolutely HAD to take at that point in my career for me to be successful?
No. It wasn’t. For me personally, doing an audiobook so early in my author journey was a living breathing example of overestimating my risk capacity.
If you’d like to learn more, D.F. Hart’s book (co-authored with Mark Leslie Lefebvre), Accounting for Authors, comes out April 12th but is available for pre-order now!