Costs

What are costs? Costs are amounts that a business incurs in order to make goods and/or provide services

Costs – what entrepreneurs need to know What it costs to produce the product or service? What the cost of marketing the product is? How high are the overheads of the business? What the potential costs of a business decision are?

Costs are important because they.. Are the thing that drains away the profits made by a business Are the difference between making a good and a poor profit margin Are the main cause of cash flow problems in a small business Change as the output or activity of a business changes – the entrepreneur needs to know how these are likely to change

Variable & fixed costs Variable costs – Costs which change as output varies – Lower risk for a start-up: no sales = no variable costs Fixed costs – Costs which do not change when output varies – Fixed costs increase the risk of a start-up

Examples of variable costs Raw materials Bought-in stocks Wages based on hours worked or amount produced Marketing costs based on sales (e.g. % commission)

Examples of fixed costs Rent & rates Salaries Advertising Insurance, banking & legal fees Software Consultant and adviser costs Design and development

Semi-fixed costs Some costs are fixed in the short- term, but then change once a certain level of output is reached Examples: – Admin salaries: stay fixed until the workload means someone else is needed – Rent: space can be enough for a certain level of output until the point at which the business needs to move to somewhere bigger (or take on more space)

Total costs The total costs of a business can be calculated using this formula: Total costs (TC) = Fixed costs (FC) + Variable costs (VC)

Total costs – example calculation Graham’s Van Repairs Business Forecasts for March Variable costs per job£75 Garage rent & rates£500 Wages£1,500 Advertising£100 Other fixed costs£400 Expected number of jobs for month100 What are Graham’s forecast total costs for March?

Graham’s Total Costs in March Stage 1 - calculate variable costs: = £75 x 100 = £7,500 Stage 2 - add together the fixed costs = £2,500 (i.e. £500 + £1,500 + £100 + £400) Stage 3 - add variable to fixed costs: Total costs are £10,000 (£7,500 + £2,500)

Problems estimating costs Some costs are easy to estimate and control: – Rent, salaries, advertising campaign Others are much harder – Raw materials – affected by wastage – Product returns or refunds – affected by quality – Where the entrepreneur does not have detailed experience of a market

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