Tuesday, 24 Dec 2024
Businesses are like computer systems that generate an output when fed with an input. Commercial entities generate revenue when the internal systems are propelled by different operations that incur significant expenses. Every business activity, ranging from administration and marketing to production and distribution, requires spending. They require sufficient working capital to keep the processes moving and generating the desired income. Whether it is the establishment, growth or rebranding of the entity, entrepreneurs have to bear expenses to stay afloat.
They must keep track of these costs to ascertain spending and income in a specific period. It helps them understand the profitability of the entity and understand how the funds are being utilised. They should be aware of the fixed, variable and semi-variable costs that impact the finances every month and quarter. Melbourne bookkeepers differentiate them to forecast expenses and create an effective budget accurately.
Fixed business costs are expenses that remain unchanged even when the production volume and sales increase or decrease. These expenses are not affected by the income generated by the entity and are recurring in nature, such as commercial property leases, repayment instalments of loans and insurance premiums. These costs are highly significant for maintaining operations and the payments cannot be missed.
Fixed costs can be reduced if the business is facing financial distress with the help of effective bookkeeping measures, such as moving to a commercial property with a lower rent or leasing equipment instead of purchasing new assets. These costs have a fixed payment time frame, such as monthly, quarterly, or annually, and are therefore also known as period costs.
Variable business costs are expenses that change based on the production and sales volume. These costs are directly proportional to the production or sales of the entity. A variety of expenses come under the variable category, such as utility bills, distribution, packaging, labour, inventory, etc. These costs increase when production is high and decrease when it is low. Experienced bookkeepers in Melbourne use the following formula to calculate this expense: Variable business cost = Total output of the entity × Variable cost per unit of the output.
Business owners must evaluate variable costs to identify the factors impacting total expenses. This is also crucial for deciding the pricing of products and services. Based on changes in variable costs, entrepreneurs can increase or reduce product prices to maintain profitability.
Semi-variable business costs are expenses that are a blend of fixed and variable cost components. The fixed component of the expense is unaffected by the production volume, but the variable part increases and decreases with the level of production. For example, property maintenance costs, energy bills and telephone bills, payroll, etc. Energy bill becomes semi-variable when it has a fixed service fee component and a variable part that is based on the utilisation of energy.
Similarly, payroll becomes semi-variable because it has a fixed and variable component that depends on the performance-based incentives. It can be calculated using the formula: Semi-variable cost = Fixed cost component + (Variable cost per unit x Total number of units). For example, if the salary of an employee is $400 and the incentive for each sale beyond the target is $20, then the semi-variable cost will be $400 + ($20 x 10) = $600 (if the employee completes ten extra sales in the month). Some direct expenses are considered semi-variable costs because of their variable component.
Melbourne bookkeepers identify different business costs because of their impact on financial management. They must know the fixed costs to evaluate the expense of running a business and determine the viability of new markets for expansion. If the fixed costs are too high, the market may not be suitable for the entity. Similarly, bookkeepers track variable costs to determine the optimum amount of production to maintain steady profits. The semi-variable costs are calculated to check the operational efficiency of the entity.
Entrepreneurs must understand that higher fixed costs mean the business needs to generate more revenue to meet its expenses and maintain a positive cash flow. Also, some of the variable costs can go down when production increases. For example, the business owner can adopt tech tools to automate processes and reduce operational expenses. Tech automation improves the quantity and quality of products and services and reduces overheads. Many of these apps are free and do not involve any additional costs.
Marginal business costs are expenses incurred when the entity produces additional output by selling to more customers. They are also known as incremental costs because they increase with the increase in the number of units produced by the business. These can be considered variable costs because they increase and decrease with the volume of production.
Sunk costs are expenses the business has already incurred and cannot be recovered, such as the money spent on a failed product. Entrepreneurs must refrain from investing more money in such projects because they have low probability of generating returns. Sunk costs can be considered fixed cost but all fixed costs are not sunk costs.
Fixed, variable and semi-variable costs cannot be ignored when running a business because these expenses help ascertain the financial performance of the entity. Entrepreneurs must know how to calculate these costs and their impact on profitability to become successful.
