UNIT 3 • SHOW ME THE MONEY: FINDING, SECURING, AND MANAGING IT
UNDERSTANDING AND
MANAGING START-UP, FIXED,
AND VARIABLE COSTS
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ENTREPRENEURSHIP: Starting and Operating a Small Business, 3/e
Steve Mariotti and Caroline Glackin
Class Name
Instructor Name
Date, Semester
Performance Objectives
After this lecture, you should be able to complete the following Performance Objectives
1. Identify the investment required for business startup.
2. Describe the variable costs of starting a business.
3. Analyze your fixed operating costs and calculate gross profit.
4. Set up financial record keeping for your business.
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What Does It Cost to Operate a Business?
To run a successful business, you will need to keep
track of your costs and have more cash coming in
than is going out.
Economics of one Unit (EOU)-because everything sold
has related costs, a business can make a profit only
if the selling price per unit is greater than the cost
per unit.
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Start-Up Investment
Seed Capital: one-time expense
of opening a business.
Prototype: a model or pattern
that serves as an example of
how a product would look
and operate if it were
produced.
Brainstorm to Avoid Start-Up
surprises.
Research the Costs.
Exhibit 7-2 Start-up Investment Checklist
Item
Rent Deposit
Signage
Utility Deposits
Vehicle(s)
Other 1
Other 2
Total Start-Up Assets
Total Start-Up Requirements
Keep a Reserve Equal to OneHalf of Start-Up Investments.
Contingency Funds (10%)
Cash Reserves: emergency
funds and a pool of cash
Start-Up with Contingency
resources
Cost
Assumptions
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Predict the Payback Period
 Payback period: estimated time required to earn sufficient
net cash flow to cover start-up investments.
Start-Up Investment
Net Cash Flow per Month
 Estimate Value: a tool to determine the current value of
proposed investments, of which net present value (NPV)
is widely accepted as the most theoretically sound.
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Variable and Fixed Costs: Essential
Building Blocks
Variable Costs – expenses that vary directly with changes in
production or sales volume.
1. Variable costs fall into two subcategories: Cost of Goods
Sold
(COGS) or Cost of Services Sold (COSS)
- The cost of materials used to make the product (or deliver the service).
- The cost of labor used to make the product (or deliver the service).
2.
Other variable costs:
- Commissions or other compensation based on sales volume.
- Shipping and handling charges.
Fixed Costs – are expenses that must be paid regardless of
whether or not sales are being generated.
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Calculating Critical Costs
Calculating Total Gross Profit (Contribution Margin)gross profit per unit-the selling price minus total
variable costs plus other variable costs.
Calculating Economics of One Unit (EOU) When You
Sell Multiple Products - a business selling a variety
of products has to create a separate EOU for each
item to determine whether each is profitable.
Inventory Costs-expenses associated with materials
and direct labor for production until the product is
sold.
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Exhibit 7-4 Manufacturing Business
Economics of One Unit (EOU) Analysis
Unit = 1 Hand-Painted T-Shirt
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Average Contribution Margin
A business selling a variety of products can use average
COGS to determine an average contribution margin.
Exhibit 7-5 Retail Business
Economics of One Unit Analysis
Unit = 1 Candy Bar
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Fixed Operating Costs
Fixed operating costs -expenses that do not vary
with changes in the volume of production or
sales.
7 Common fixed operating costs: USAIIRD:
•
•
•
•
•
•
•
Utilities
Salaries
Advertising
Interest
Insurance
Rent
Depreciation
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Depreciation Makes Records More Accurate
Depreciation – the percentage of value of an asset
subtracted periodically to reflect the declining value.
If you buy a computer that will last 4 years, spread the
expense out over 4 years.
Subtract 25% of the computer’s cost from gross profit
each year, instead of subtracting 100% of the cost
from gross profit the first year.
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Fixed Operating Costs Do Change over Time
Fixed costs does not mean that costs never
changes! For instance:
Advertising or heating and cooling costs
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Allocate Fixed Operating Costs Where
Possible
Net Profit – the remainder of revenues minus fixed
and variable costs and taxes.
For example: for every watch you sell, your total
cost, fixed and variable, is $6.50. If you receive
$15 for each watch, therefore, your profit before
taxes is:
$15.00 Selling Price - $6.50 Total Cost per Unit = $8.50 Profit before
Taxes
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The Dangers of Fixed Costs
If a business does not have
enough sales to cover its
fixed costs, it will lose
money!
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How Inflation Can Hurt Small Business
Owners
Inflation: the gradual, continuous increase in the prices
of products and services.
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Using Accounting Records to Track Fixed
and Variable Costs
The systematic recording, reporting, and analysis of
the financial transactions of a business (keeping
statistical records of inflows and outflows) is called
accounting.
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Three Reasons to Keep Good Records
Every Day
1. Will show you how to make your business more
profitable.
2. Will document your business profitability.
3. Proves that payments have been made.
Audit- a review of financial and business records to
ascertain integrity and compliance with standards
and laws, particularly by the U.S. Internal Revenue
Service (IRS).
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Suggestions for Keeping Good Records
Accounting Software – There are many excellent
computer software programs on the market to help
the small business owner keep good records and
generate financial statements and analytical reports;
Intuit QuickBooks, Microsoft Office Accounting, &
Peachtree Accounting.
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Receipts and Invoices
Receipt = document with date a amount of
purchase. Always get a receipt for every
purchase you make
Invoice = a bill or statement, shows the
product or service sold and the amount
the customer is to pay.
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Keep at Least Two Copies of Your Records

Always keep a copy of your financial records in a
location away from your business, preferably in a
fire-retardant safe or concrete-lined file cabinet.

If you are using software, back up your data and
keep the media (CD, jump drive, etc…) in a
different location.
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Use Business Checks for Business Expenses
Avoid using cash for business. Use
checks, get receipts. Keep a paper trail.
Deposit money from sales right away.
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Cash versus Accrual Accounting Methods
Cash Accounting Method – the procedure wherein
transactions are recorded as cash as paid out or
received.
Accrual Method – Account process wherein
transactions are recorded at the time of occurrence,
regardless of the transfer of cash.
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Recognizing Categories of Costs
Understanding the key categories of accounting data:
-
Variable Costs
Fixed Costs
Capital Equipment
Investment
Loans
Revenue
Inventory
Other Costs
KEY TERMS
accrual method
audit
cash accounting method
cash reserve
contribution margin
depreciation
fixed costs
fixed operating costs
inflation
inventory costs
net profit
payback period
prototype
seed capital
variable costs