Todays Objectives ObjectiveEssential Questions Identify the
cost of operations How can you calculate cost of operations? How
can you calculate cash flow?
Slide 3
Costs The costs of starting and operating a business are
divided into the following categories: 1. Startup costs 2. Cost of
goods sold 3. Operating costs, including fixed costs and variable
costs
Slide 4
The Costs of Operation Startup costs Startup costs are the
one-time expenses of starting a business. They are also called the
original investment. In a restaurant, for example, this would
include: Stoves, food processors, tables, chairs, silverware, and
other items that are not replaced on a regular basis. Also included
might be the on-time cost of buying land and constructing a
business.
Slide 5
For a hot-dog stand, startup costs might look like this:
Hot-dog Cart$1,500.00 Business License 200.00 Starting Supplies
(hot dogs, buns, mustard) 300.00 Business Cards & Fliers 50.00
Telephone Answering Machine 100.00 Total Startup
Costs$2,150.00
Slide 6
Operating Costs operating costs The operating costs of a
business are those costs that are necessary to operate the
business, not including the cost of goods sold.
Slide 7
Operating Costs Operating costs can almost always be divided
into six categories 1. Utilities (gas, electric, telephone) 2.
Salaries 3. Advertising 4. Insurance 5. Interest 6. Rent
Slide 8
Operating Costs overhead. Operating costs are also called
overhead.
Slide 9
Operating Costs Fixed costs stay the same Fixed costs are
operating costs that stay the same, regardless of the range of
sales the business is making. Rent can be an example of a fixed
cost. Whether a shoe store sells 200 or 300 pairs of shoes in a
month, it still pays the same rent on the store, so the rent is
considered a fixed cost.
Slide 10
Operating Costs Variable costs change Variable costs are
operating costs that change, depending on the volume of sales, but
cannot be assigned directly to the unit of sale. If cost can be
assigned directly to a unit of sale, it should be viewed a part of
the cost of goods sold.
Slide 11
Operating Costs An example of a variable cost might be
electricity. A flower shop, for example, stores many more flowers
in its refrigerators around Easter or Mothers Day. The
refrigerators require more electricity to cool all the flowers.
Electricity, therefore, is an operating cost that is higher when
the store is selling more flowers.
Slide 12
Cost of Goods or Services Sold cost of goods sold one
additional unit The cost of goods sold can be thought of as the
cost of selling one additional unit of a product. cost of services
sold The cost of services sold is the cost of serving one
additional customer. The total cost of goods sold increases as the
number of customers served increases.
Slide 13
An example of the cost of goods sold of a turkey sandwich is
shown in the following table: ItemAnalysisCost per Sandwich Turkey
4 oz.$2.60 per pound$0.65 Bread large roll0.32 per roll 0.16
Mayonnaise 1 oz.1.60 per 32-oz jar0.05 Lettuce 1 oz.0.80 per
pound0.05 Tomato2.20 per pound0.28 Pickle 0.20 per pickle0.05
Wrapper10.00 per 1,0000.01 Cost of goods sold $1.25
Slide 14
Gross Profit Per Unit Once you know your cost of goods sold and
have defined your unit, you can calculate your gross profit per
unit. gross profit per unit The cost of goods sold of the sandwich,
subtracted from the price customers pay for the sandwich, equals
the gross profit per unit for the sandwich.
Slide 15
The equation to calculate gross profit per unit: Selling Price
Cost of Goods Sold = Gross Profit per Unit
Slide 16
Calculating Gross Profit Per Unit In the case: ItemCost Price
of sandwich$4.00 Cost of goods sold-1.25 Gross profit per sandwich
$2.75
Slide 17
Cost of Goods Sold As an entrepreneur, you must keep the cost
of goods sold secret. If customers learn your cost of goods sold,
theyll use that information to try to negotiate a lower selling
price.
Slide 18
Profit Gross profit only subtracts cost of goods sold (for a
product business) from revenue. operating costs It does not take
into account the operating costs of running a business. To figure
profit, the entrepreneur must subtract operating costs from gross
profit.
Slide 19
Profit The Equation for calculating Profit is: Gross Profit
Operating Costs = Profit
Slide 20
Profit Per Unit It is also important to know how much of the
sale of each unit is profit. An easy way to calculate profit per
unit is to divide total units sold into profit, such as the example
below: $125.00 total profit 10 units sold = $12.50 per unit In this
example, the entrepreneur is earning a profit of $12.50 for each
unit (product) sold. Profit Units Sold = Profit per Unit
Slide 21
Tracking Your Cash Flow An entrepreneur cannot effectively
guide a businesses daily operations using the income statement
alone. It is also important to use a monthly cash flow statement to
track the cash going in and out of the business.
Slide 22
Cash Flow Cash flow is simply the difference between the money
you take in and the money you spend. Remember, cash is the
lifeblood of your business. If you run out of cash, your business
is dead. Without cash on hand, you may find yourself unable to pay
important bills even if your income statement says you are earning
a profit.
Slide 23
Cash Flow Discrepancies between cash on hand and projected
profits on an income statement occur because there is often a time
lapse between when you make a sale and when you receive the cash
for that sale.
Slide 24
Noncash Expenses The income statement can also distort your
cash picture because it may include noncash expenses like
depreciation. When you depreciate an asset, you deduct a portion of
its cost from your Income Statement. But you arent actually
physically spending that amount of cash. You dont hand anyone cash
when you record a depreciation expense on your income
statement.
Slide 25
Noncash Expenses Depreciation is a noncash expense because
theres no cash going out of the business. If depreciation is
deducted from an income statement, then the income statement no
longer accurately reflects how much cash the business is really
holding. The cash flow statement requires you to add back the
amount of depreciation that was deducted from the income
statement.
Slide 26
Your Cash Position As an entrepreneur, you need a cash flow
statement to depict the cash position of your business at specified
points in time. A cash flow statement records inflows and outflows
of cash when they occur. If a sale is made in June but the customer
doesnt pay until August, the income statement will show the sale in
June and the cash flow statement will show the sale in August.
Slide 27
Cash Flow Statement Cash Inflows Sales, 3/1-3/31$65,400 Total
Cash Inflows$65,400 Cash Outflows Cost of Goods Sold$29,360 Factory
Rent and Utilities8,000 Salaries and Administrative12,000 Sales
Commissions6,540 Total Cash Outflows$53,900 Net Cash Flow Before
Taxes(65,400-$53,900) = $11,500 Taxes($11,500 *.25)= 2,875 Net Cash
Flow$8,625
Slide 28
Risking Your Cash on Inventory An entrepreneur takes a risk
every time she/he spends cash. If you buy inventory, for example,
you take the risk that no one will buy it or that no one will be
willing to spend what you paid for it or more, so that you can make
a profit.
Slide 29
Risking Your Cash on Inventory There are two other risks with
inventory: Storage costs and Pilferage
Slide 30
Risking Your Cash on Inventory You have to make sure you can
sell the inventory at a price that will cover any costs of storing
it. You also need to cover the cost of theft by employees and
customers. For example, Barneys (the famous New York clothing
store) has 7% pilferage rate, which contributed to driving it out
of business.
Slide 31
Risking Your Cash on Inventory There is also the danger that
youll invest in inventory because you expect to receive cash from
customers who owe you money (accounts receivable). Be aware that a
percentage of your accounts receivables will probably never be
collected. These are all reasons to keep an ongoing cash flow
statement for your business.
Slide 32
Forecasting Cash Flow As you get your business off the ground,
youll need to prepare monthly cash flow projections to make sure
youll have enough cash coming in to pay your bills.
Slide 33
Forecasting Cash Flow You can forecast cash flow in two steps:
1. Project your cash receipts from all possible sources. Remember,
orders are not cash receipts because you cant guarantee that every
order will yield cash. Some orders may be canceled, some customers
may not pay up. Cash receipts are checks that you are sure are
going to clear.
Slide 34
Forecasting Cash Flow You can forecast cash flow in two steps:
2. Subtract from these projected cash receipts any expenses you
expect to have. Cash expenses are only those expenses you will
actually have to pay during the projected time period.
Slide 35
Forecasting Cash Flow You cant necessarily be sure these
projections will be accurate, but do them anyway. Review and update
them constantly.
Slide 36
Cumulative Cash Flow Graph It is suggested that entrepreneurs
should plot the businesss cumulative cash flow on a simple graph to
see how the business is doing. The goal is to eventually see cash
flow increase. The following example shows a business that needs to
raise financing to meet its negative cash flow.