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Toolkit on how to Start and Improve your Business Cost Calculation |
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Simplified sales and cost plan format Year ………..
Types of direct cost: Direct costs: Are those costs incurred in direct proportion to the volume of output or to the time spent on making a specific number of units of the product. Direct material costs - are all the money your business spends on the parts and materials that become part of, or are directly related to, the products or services you make or sell. To be counted as direct material costs, the amount of material must be easy to calculate, and the cost of the material must be big enough to add a considerable amount to the total direct material costs. If this is not the case, they may be considered as indirect costs. Direct labour costs - are all the money your business spends on wages, salaries and benefits for the people who are directly involved in the production of your products or services. The time spent on making the product must be easy to calculate, and the cost of the labour must be big enough to add a considerable amount to the total direct labour costs. If this is not the case, they may be considered as indirect costs. Indirect costs - are all other costs that you have incurred by running your business when running your business, for example rent, interest and electricity. Indirect costs are not directly related to one particular product or service. They are sometimes called overheads or expenses. Manufacturing cost - is the sum of direct material cost, direct labour cost and manufacturing overheads. Non-manufacturing cost - is the sum of selling expenses and general and administrative expenses. Factory overhead - includes costs such as auxiliary materials, factory/workshop supplies, supervision, tea for workers, depreciation of building and equipment, maintenance/repair of tools, equipment and machinery. Administrative cost - includes costs such as salaries, depreciation (office equipment, etc), office supplies, communication, transport, insurance, rent, taxes/fees and financial charges or interest on loans.
Selling expenses - salaries, packaging, transport, allowances for sales persons, communications and promotions and miscellaneous others. Full cost - is the sum of manufacturing and non-manufacturing costs.
Suggested examples for direct and indirect costs
Fixed costs and variable costs: Some costs vary with the volume of production or services, whilst others do not. This means that certain costs increase or decrease proportionally with the increase or decrease in production activities. These costs are called variable costs. Fixed costs, however, do not generally change over a range of different production levels except in the long run. Depreciation: A cost charged against fixed assets for their replacement. Fixed assets are depreciated over time to reflect the decline in value of these assets. Depreciation is a tax deductible but non-cash expense for the business and does not appear in the cash flow. Many people are unaware of costs and waste scarce resources. Be cost conscious and think about systematic but simple cost calculation! Cost calculation is the way to calculate the total costs of making and selling a product or providing a service. How can it improve the business? Costing helps you to:
Steps of cost calculation: 1. Identify cost components; 2. Systematise costs; 3. Calculate variable costs; 4. Calculate fixed costs; 5. Calculate total costs per unit; 6. Set prices, deduct the breakeven point.
It is also important to know and identify cost components involved in your enterprise as follows: Production: Manpower; raw materials; electricity, transport, rent, water; machinery, equipment and tools. Management: Manpower, entrepreneur’s salary; stationery, telephone, rent, electricity, insurance; equipment. Selling: Publicity, promotion, commissions. Finance: Interest.
Cash-flow plan: It is a forecast which shows you how much cash you can expect to flow into your business and how much cash you expect to go flow out of your business each month. A cash flow forecast helps you make sure that your business does not run out of cash at any time. That means that it helps predict cash needed - how much money will be needed and when it will be needed - or to predict cash surplus and plan investment. A business with more cash outflow than inflow will soon get into trouble. It will not be able to pay its expenses when they fall due.
* The
cash balance at the end of the previous month shall be foreworded to the
Components of a balance sheet: The balance sheet is the statement of assets and liabilities and gives the financial picture of the business as of a certain date, for example, at the end of the year.
Balance sheet (example for first year of operation)
Note: Total asset = total liability + total owner's equity.
Break-even point analysis Break-even analysis is a tool to determine the level of production/sales at which the project will cover both fixed and variable costs. It indicates the minimum amount of revenue that the project must earn in order to cover the total cost incurred so that it does not incur any loss. For the break-even analysis costs are categorised into variable and fixed costs. In addition, it is important to know the level of the Contribution Margin (CM). What is a contribution margin?
The
Contribution Margin (CM) is the contribution of each unit of production
towards covering fixed costs of the project and eventually the margin of
profits. Simply, it is the difference between selling price (SP) and the
Variable Cost per Unit (VCU),
The following can help you calculate the Break-Even Point (BEP): BEP in units = Total fixed costs Contribution margin per unit The BEP can be calculated in terms of volume of production, sales revenue, plant capacity and sales price.
Examples: Installed capacity of a machine = 25,000 units per year Total fixed costs = Birr 30,000 Sales price = Birr 10 Variable Costs = Birr 7 (a) Volume of production at BEP = Fixed costs = 30,000/3 = 10,000 units CM (b) Sales revenue = Production units x sales price at BEP = 10,000 x 10 = Birr 100,000 (c) Plant capacity (%) = Number of units at BEP x 100 Number of units at full capacity = 10,000 x 100 = 40% 25,000
(d) Minimum
acceptable price = Total fixed costs + Total variable
costs = Birr 30,000 + (15,000 units x Birr 7) 15,000 units = 135,000/15,000 = Birr 9 The minimum price will be lower if production is more, say 20,000 units. In this case, the minimum price will be Birr 8.5. Return on Investment (ROI): Is a measure of profitability and it helps you decide whether or not to go ahead with your business idea. ROI = Net Profit/Total Equity x 100. If the percentage is greater than bank deposit rate, then the project appears viable.
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