Entrepreneurship Chapter 6 Tracking Fixed and Variable Costs

Variable Costs Variable costs vary (change) with sales: 1. Cost of goods sold (COGS) – cost of materials, labor 2. Other variable costs – commisions, shipping, handling etc. Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.

Fixed Operating Costs Fixed operating costs must be paid whether or not the business makes any sales. USAIIRD: n n n n Utilities Salaries Advertising Interest Insurance Rent Depreciation (method used to “expense” expensive pieces of equipment) Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.

Contribution Margin Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All

Average Contribution Margin A business selling a variety of products can use average COGS to determine an average contribution margin. Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.

Economics of One Unit Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ,

Depreciation Makes Records More Accurate n n 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. Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.

Insurance Protects Business Buy insurance to protect your business from: n Fire and other natural disasters n Theft n Liability (lawsuits) Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.

Basic Coverage for Small Business Required by most states: n n n Workers’ Compensation Disability Insurance Auto Insurance Premium: monthly payment on insurance policy Deductible: amount of loss you agree to cover Lower deductible = higher premium Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.

Lying About Your Product Is Fraud n n If a customer can prove that you knew your product/service was dangerous, you can be forced by a court to pay damages. Companies that sell products/services that can cause harm (airlines, for example) must inform customers of dangers and carry sufficient insurance. Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.

Fixed Operating Costs can be Dangerous to a Business n n n Fixed costs must be paid even when a business has no sales. Bills must be paid! Keep at least 3 months fixed costs as a cash reserve before opening your business. Change fixed costs to variable costs wherever possible. Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.

Start-Up Investment n n One-time expense of starting a business Brainstorm every cost to avoid surprises Ask advisors to go over your list Add 10% for emergencies and costs you overlooked Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.

Payback Start-Up Investment ($1, 000) = 5 months Net Profit per month ($400) Tells investors how long it will take business to earn enough profit to cover start-up costs. Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.

Accounting: Keeping Track of Money Inflows and Outflows Financial statements: 1. Income statement 2. Cash flow statement 3. Balance sheet Keep good daily records of cash inflows and outflows in order to create financial statements that will describe your business’s performance at a glance. Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.

3 Reason to Keep Good Daily Records 1. Good records show you how to make your business more profitable. 2. Good records will prove your business is profitable. 3. Good records prove payments have been made. 4. Good records prove you have paid required taxes. Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.

Receipts and Invoices n n Receipt: paper with date, amount of purchase Invoice (bill): paper with date, amount of payment due on purchase 1. Keep a copy of financial records in location away from business office. 2. Back up all computer records. Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.

Open Business Checking Account n n Avoid using cash for business: Use checks, get receipts. Keep a paper trail. Deposit money from sales in checking account right away. Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.

“Cash Only” Accounting n n Only make entry in accounting journal when you receive money or pay out money. Each entry on left side of journal must have a matching entry/description on the right side. Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.

Journal Left Side Right Side Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River,

Blank Accounting Journal —Left Side Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River,

Blank Accounting Journal —Right Side Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River,

Return on Investment (ROI) n n n Net Profit/Investment = ROI To express ROI as a percentage, multiply by 100. ROI X 100 = ROI% ROI tells you the rate of return on your start-up investment in the business. Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.

NFTE Journal Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All

Relationship Between Accounting Journal and Financial Statements Marriotti: Entrepreneurship © 2007 Pearson Education. Upper

Summary Ledger with Income Statement and Balance Sheet Marriotti: Entrepreneurship © 2007 Pearson Education.

3 Rules for Managing Cash 1. Collect cash as soon as possible. 2. Delay paying bills as long as possible without damaging relationships with suppliers. 3. Always know your cash balance. Use accounting journal to calculate it every day. Marriotti: Entrepreneurship © 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.