Entrepreneurship and small business management chapter 12

Entrepreneurship and
Small Business
Management
Chapter 12
Understanding and Managing
Start-up, Fixed, and Variable
Costs


Ch. 12 Performance
Objectives








Identify the investment required
for business startup.
Describe the variable costs of
starting a business.
Analyze your fixed operating
costs and calculate gross profit.
Set up financial record keeping
for your business.

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Start-Up Investment


Seed capital is the
one-time expense of
starting a business.



Brainstorm every cost
to avoid surprises.



Consult advisors and
research industry
business plan models.



Include a cash
reserve for
emergencies.

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Predict the Payback Period
Start-up investment
= no. of
Net cash flow per mo.
months
This estimate tells investors how
long it will take your business to
bring in enough cash to cover the
start-up investment.
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Estimate Net Present
Value




NPV—technique used to determine the
current value of a proposed investment
Information used to calculate NPV:


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Initial investment
Required rate of return (%)
Annual net cash flows

If NPV is a positive value, the
investment will have a positive return.

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Variable Costs


Change based on sales and production



Cost of goods sold (COGS) or Cost of
services sold (COSS)





Cost of materials
Cost of labor

Other variable costs



Sales commissions
Shipping and handling

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Finding the Contribution
Margin

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Average Contribution
Margin
A business selling a variety of products
can use an average COGS to determine
an average contribution margin.

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© 2012 Pearson Education, Upper Saddle River, NJ
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Fixed Operating Costs




Do not change based on sales/production
USAIDIR (common fixed operating costs)




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Utilities (gas, electric, telephone, Internet)
Salaries (indirect labor)
Advertising
Insurance
Depreciation
Interest
Rent

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Depreciation Makes Records

More Accurate


If you buy a computer that will last
four years, spread the expense out
over four years.



Subtract 25% of the computer’s
cost from gross profit each year,
instead of subtracting 100% of the
cost from gross profit the first year.

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© 2012 Pearson Education, Upper Saddle River, NJ
07458.


Fixed Operating Costs Can be
Dangerous to a Business


Fixed costs must be paid whether or
not your business has a gross profit.



Be careful about taking on additional
fixed costs.



Change fixed costs to variable costs
wherever possible.



Keep a cash reserve as a cushion of
protection in case of emergencies.

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Keeping Good Records


Accounting—tracking the inflows and
outflows of your business



Good records enable you to…



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
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Create financial statements
Determine how to improve business
profits
Show investors the firm’s performance
Prove that payments have been made
Make audits go more smoothly

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© 2012 Pearson Education, Upper Saddle River, NJ
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Good Accounting Practices


Use computerized accounting

software.



Get a receipt for every purchase.



Create an invoice for every sale.



Backup computer records regularly.

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© 2012 Pearson Education, Upper Saddle River, NJ
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Good Accounting Practices
(continued)


Keep a copy of financial records in a
location away from the business
office.



Get a checking account for business
use only.




Use checks instead of cash to pay
business expenses.
Deposit money from sales right away.

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Cash Versus Accrual
Methods


Cash accounting—transactions
are recorded when cash is paid or
received



Accrual accounting—
transactions are recorded at the
time they occur, regardless of the
payment date

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Categories of Accounting Data


Variable costs—any costs that change
based on the number of units sold



Fixed costs—business expenses that must
be paid whether or not any sales are made



Capital equipment—money spent on

equipment expected to last a year or more



Investment—money invested in exchange
for part ownership (equity)

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© 2012 Pearson Education, Upper Saddle River, NJ
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Categories of Accounting
Data
(continued)


Loans—funds borrowed to start or
operate the business



Revenue—money received from sales



Inventory—items purchased for resale,
including suppliers’ shipping costs



Other costs—anything that does not
fit into the other expense categories

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© 2012 Pearson Education, Upper Saddle River, NJ
07458.