Entrepreneurship and Small Business Management

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 RecordsMore 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