Entrepreneurship: Chapter 6

FIXED V/S VARIABLE EXPENSES

DR. T.K. JAIN

Variable Costs

Variable costs vary (change) with sales:

1. Cost of goods sold (COGS)

cost of materials, labor

2.Other variable costs

commisions, shipping, handling etc.

Identify fixed and variable

Fixed Operating Costs

Fixed operating costs must be paid whether or not the business makes any sales.

Utilities

Salaries

Advertising

Interest

Insurance

Rent

Depreciation (method used to expense expensive pieces of equipment)

Contribution Margin

How to calculate contribution

Average Contribution Margin

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

Economics of One Unit

Depreciation Makes Records More Accurate

If you buy a computer that will last 4 years, spread the expense out over 4 years.

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

Insurance Protects Business

Fire and other natural disasters

Theft

Liability (lawsuits)

Buy insurance to protect your business from:

Basic Coverage for Small Business

Required by most states:

Workers Compensation

Disability Insurance

Auto Insurance

Premium: monthly payment on insurance policy

Deductible: amount of loss you agree to cover

Lower deductible = higher premium

Lying About Your Product Is Fraud

If a customer can prove that you knew your product/service was dangerous, you can be forced by a court to pay damages.

Companies that sell products/services that can cause harm (airlines, for example) must inform customers of dangers and carry sufficient insurance.

Fixed Operating Costs can be Dangerous to a Business

Fixed costs must be paid even when a business has no sales. Bills must be paid!

Keep at least 3 months fixed costs as a cash reserve before opening your business.

Change fixed costs to variable costs wherever possible.

Start-Up Investment

One-time expense of starting a business

Brainstorm every cost to avoid surprises

Ask advisors to go over your list

Add 10% for emergencies and costs you overlooked

Payback

Start-Up Investment ($1,000)

Net Profit per month ($400)

Tells investors how long it will take business to earn enough profit to cover start-up costs.

= 5 months

Accounting: Keeping Track of Money Inflows and Outflows

Financial statements:

Income statement

Cash flow statement

Balance sheet

Keep good daily records of cash inflows and outflows in order to create financial statements that will describe your businesss performance at a glance.

3 Reason to Keep Good Daily Records

Good records show you how to make your business more profitable.

Good records will prove your business is profitable.

Good records prove payments have been made.

Good records prove you have paid required taxes.

Receipts and Invoices

Receipt: paper with date, amount of purchase

Invoice (bill): paper with date, amount of payment due on purchase

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

Back up all computer records.

Open Business Checking Account

Avoid using cash for business: Use checks, get receipts. Keep a paper trail.

Deposit money from sales in checking account right away.

Cash Only Accounting

Only make entry in accounting journal when you receive money or pay out money.

Each entry on left side of journal must have a matching entry/description on the right side.

3 Rules for Managing Cash

Collect cash as soon as possible.

Delay paying bills as long as possible without damaging relationships with suppliers.

Always know your cash balance. Use accounting journal to calculate it every day.

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