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UNDERSTANDING AND MANAGING START-UP, FIXED, AND VARIABLE COSTS. UNIT 3 • SHOW ME THE MONEY: FINDING, SECURING, AND MANAGING IT. Class Name Instructor Name Date, Semester. Performance Objectives After this lecture, you should be able to complete the following Performance Objectives.

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UNDERSTANDING AND MANAGING START-UP, FIXED, AND VARIABLE COSTS
  • UNIT 3 • SHOW ME THE MONEY: FINDING, SECURING, AND MANAGING IT

Class Name

Instructor Name

Date, Semester

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Performance Objectives

After this lecture, you should be able to complete the following Performance Objectives

1. Identify the investment required for business startup.2. Describe the variable costs of starting a business.3. Analyze your fixed operating costs and calculate gross profit.4. Set up financial record keeping for your business.

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What Does It Cost to Operate a Business?

To run a successful business, you will need to keep track of your costs and have more cash coming in than is going out.

Economics of one Unit (EOU)-because everything sold has related costs, a business can make a profit only if the selling price per unit is greater than the cost per unit.

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Start-Up Investment

Seed Capital: one-time expense of opening a business.

Prototype: a model or pattern that serves as an example of how a product would look and operate if it were produced.

Brainstorm to Avoid Start-Up surprises.

Research the Costs.

Keep a Reserve Equal to One-Half of Start-Up Investments. Cash Reserves: emergency funds and a pool of cash resources

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Predict the Payback Period

Payback period: estimated time required to earn sufficient net cash flow to cover start-up investments.

Start-Up Investment

Net Cash Flow per Month

 Estimate Value: a tool to determine the current value of proposed investments, of which net present value (NPV) is widely accepted as the most theoretically sound.

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Variable and Fixed Costs: Essential Building Blocks

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Variable Costs – expenses that vary directly with changes in production or sales volume.

1. Variable costs fall into two subcategories: Cost of Goods Sold

(COGS) or Cost of Services Sold (COSS)

    • The cost of materials used to make the product (or deliver the service).
    • The cost of labor used to make the product (or deliver the service).
  • Other variable costs:
    • Commissions or other compensation based on sales volume.
    • Shipping and handling charges.

Fixed Costs – are expenses that must be paid regardless of whether or not sales are being generated.

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Calculating Critical Costs

Calculating Total Gross Profit (Contribution Margin)-gross profit per unit-the selling price minus total variable costs plus other variable costs.

Calculating Economics of One Unit (EOU) When You Sell Multiple Products - a business selling a variety of products has to create a separate EOU for each item to determine whether each is profitable.

Inventory Costs-expenses associated with materials and direct labor for production until the product is sold.

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Average Contribution Margin

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

Exhibit 7-5 Retail Business

Economics of One Unit Analysis

Unit = 1 Candy Bar

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Fixed Operating Costs

Fixed operating costs -expenses that do not vary with changes in the volume of production or sales.

7 Common fixed operating costs: USAIIRD:

  • Utilities
  • Salaries
  • Advertising
  • Interest
  • Insurance
  • Rent
  • Depreciation
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Depreciation Makes Records More Accurate

Depreciation – the percentage of value of an asset subtracted periodically to reflect the declining value.

If you buy a computer that will last 4 years, spread the expense out over 4 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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Fixed Operating Costs Do Change over Time

Fixed costs does not mean that costs never changes! For instance:

Advertising or heating and cooling costs

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Allocate Fixed Operating Costs Where Possible

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Net Profit – the remainder of revenues minus fixed and variable costs and taxes.

For example: for every watch you sell, your total cost, fixed and variable, is $6.50. If you receive $15 for each watch, therefore, your profit before taxes is:

$15.00 Selling Price - $6.50 Total Cost per Unit = $8.50 Profit before Taxes

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The Dangers of Fixed Costs

If a business does not have enough sales to cover its fixed costs, it will lose money!

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How Inflation Can Hurt Small Business Owners

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Inflation: the gradual, continuous increase in the prices of products and services.

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Using Accounting Records to Track Fixed and Variable Costs

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The systematic recording, reporting, and analysis of the financial transactions of a business (keeping statistical records of inflows and outflows) is called accounting.

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Three Reasons to Keep Good Records

Every Day

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  • Will show you how to make your business more profitable.
  • Will document your business profitability.
  • Proves that payments have been made.

Audit- a review of financial and business records to ascertain integrity and compliance with standards and laws, particularly by the U.S. Internal Revenue Service (IRS).

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Suggestions for Keeping Good Records

Accounting Software – There are many excellent computer software programs on the market to help the small business owner keep good records and generate financial statements and analytical reports; Intuit QuickBooks, Microsoft Office Accounting, & Peachtree Accounting.

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Receipts and Invoices

Receipt = document with date a amount of purchase. Always get a receipt for every purchase you make

Invoice = a bill or statement, shows the product or service sold and the amount the customer is to pay.

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Keep at Least Two Copies of Your Records

  • Always keep a copy of your financial records in a location away from your business, preferably in a fire-retardant safe or concrete-lined file cabinet.
  • If you are using software, back up your data and keep the media (CD, jump drive, etc…) in a different location.
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Use Business Checks for BusinessExpenses

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

Deposit money from sales right away.

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Cash versus Accrual Accounting Methods

Cash Accounting Method – the procedure wherein transactions are recorded as cash as paid out or received.

Accrual Method – Account process wherein transactions are recorded at the time of occurrence, regardless of the transfer of cash.

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Recognizing Categories of Costs

Understanding the key categories of accounting data:

  • Variable Costs
  • Fixed Costs
  • Capital Equipment
  • Investment
  • Loans
  • Revenue
  • Inventory
  • Other Costs
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Key Terms

accrual method

audit

cash accounting method

cash reserve

contribution margin

depreciation

fixed costs

fixed operating costs

inflation

inventory costs

net profit

payback period

prototype

seed capital

variable costs