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

2. 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.

3. 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.

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

5. Estimate Net Present Value
NPV—technique used to determine the current value of a proposed investment
Information used to calculate NPV:
Initial investment
Required rate of return (%)
Annual net cash flows
If NPV is a positive value, the investment will have a positive return.

6. 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

7. Finding the Contribution Margin

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

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

10. 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.

11. 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.

12. Keeping Good Records
Accounting—tracking the inflows and outflows of your business
Good records enable you to…
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

13. Good Accounting Practices
Use computerized accounting software.
Get a receipt for every purchase.
Create an invoice for every sale.
Backup computer records regularly.

14. 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.

15. 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

16. 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)

17. 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