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Page 1: Costs. What are costs? Costs are amounts that a business incurs in order to make goods and/or provide services

CostsCosts

Page 2: Costs. What are costs? Costs are amounts that a business incurs in order to make goods and/or provide services

What are costs?

Costs are amounts that a business incurs in order to

make goods and/or provide services

Page 3: 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?

Page 4: Costs. What are costs? Costs are amounts that a business incurs in order to make goods and/or provide services

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

Page 5: Costs. What are costs? Costs are amounts that a business incurs in order to make goods and/or provide services

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

Page 6: Costs. What are costs? Costs are amounts that a business incurs in order to make goods and/or provide services

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)

Page 7: Costs. What are costs? Costs are amounts that a business incurs in order to make goods and/or provide services

Examples of fixed costs

• Rent & rates• Salaries• Advertising• Insurance, banking & legal

fees• Software• Consultant and adviser

costs• Design and development

Page 8: Costs. What are costs? Costs are amounts that a business incurs in order to make goods and/or provide services

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)

Page 9: Costs. What are costs? Costs are amounts that a business incurs in order to make goods and/or provide services

Total costs

The total costs of a business can be calculated using this

formula:Total costs (TC) = Fixed costs (FC) +

Variable costs (VC)

Page 10: Costs. What are costs? Costs are amounts that a business incurs in order to make goods and/or provide services

Total costs – example calculation

Graham’s Van Repairs BusinessForecasts for MarchVariable costs per job £75

Garage rent & rates £500

Wages £1,500

Advertising £100

Other fixed costs £400

Expected number of jobs for month 100

What are Graham’s forecast total costs for March?

Page 11: Costs. What are costs? Costs are amounts that a business incurs in order to make goods and/or provide services

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)

Page 12: Costs. What are costs? Costs are amounts that a business incurs in order to make goods and/or provide services

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

Page 13: Costs. What are costs? Costs are amounts that a business incurs in order to make goods and/or provide services

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