Basic
Accounting Principles:
There are two distinct types of outlays in running a business.
Capital expenditure.
Operating cost.
Capital expenditure Capital expenditure are Items
bought for the business like real-estate, plant, equipment, vehicles, etc an asset that
the business owns but has no direct bearing on the profit the business generates, it is
simply transforming one asset into another e.g. (cash into a Vehicle).
Operating cost Operating cost are the outlays
that go into the production of the goods or services that can not be turned back into
Trade or Cash. They have been expended and so have diminished the profit of the business.
The depreciation of capital expenditure or interest on bank loans should be claimed as an
operating cost.
Operating
expenses must be divided into two different parts Fixed or Variable cost so you
can clearly identifier which cost will be effected by sales volume of goods or services
provided and which cost remain unaffected.
Fixed cost Fixed cost remains constant
while volume goes up or down e.g. Property and equipment leases, loan repayments,
depreciation, rates, insurance etc.
If the manufacturer of widgets rents a
factory for $10,000 pa and manufactured 10,000 widgets then $1 would have to be added to
the cost per unit. If only 5,000 widgets where manufactured then $2 would have to be
added to the unit cost.
Variable cost Variable cost vary in response
to the volume of sales or production, volume goes up so do variable cost. E.g. raw
material, petrol, casual labor, commissions etc.
Equation:
Equation:
Total sales - (Variable cost + fixed cost) = Profit.
If widgets sell for $100 per unit and
variable cost may be $30 raw materials, $5 delivery, $25 labor, $8 commission. Variable
cost per unit is $68.
Variable
Costs Ratio Variable
Costs Ratio is (variable cost per unit) divided by (sales price per unit).
(Variable cost $68) divided by (unit
sales price 100) = 0.68
Fixed cost for the year are $78,000
You can now use this Ratio to calculate
the projected profit or loss at different levels of sales volume.
Now remember variable cost go up as
volume goes up so multiply by Ratio value E.g.: sales -(variable cost + fixed cost) = net
profit/loss
0 -(0 x 0.68 + $78,000) = loss $78,000
$150,000 -($150,000 x 0.68 + $78,000) =
loss $28,000
$240,000 -($240,000 x 0.68 + $78,000) =
breakeven point
$300,000 -($300,000 x 0.68 + $78,000) =
profit $19,000
$530,000 -($530,000 x 0.68 + $78,000) =
profit $92,000
$600,000 -($600,000 x 0.68 + $78,000) =
profit $115,200
You must be aware that there are some
basic assumptions that the cost, profit and volume analysis is built on. We have to assume
that:
volume is the only critical factor
affecting cost.
all cost can be classified into fixed
and variable components.
fixed cost remain constant over the
range of activity.
variable cost change in direct
relation to change in sales.
prices will not change.
productivity and efficiency will not
change.
sales mix will not alter with changes
in sales volume.
costs and sales revenue are compared
on a common base - sales value and units.
The
cost of a cash dollars is the fixed + variable cost of running your business
in the cash economy it is operating in.
The cost of a
TradeDollars
is only
the variable cost the wholesale, replacement cost &/or downtime cost of being in a virtual economy.
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