Costing of Business

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Costing of Business

• ELE 41EMT/EIB

George Alexander G.Alexander_at_latrobe.edu.au www.la
trobe.edu.au/eemanage
Lecture 8 27 April, 2004
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Starting a Business
Starting and successfully operating a business
requires

• A good business idea
• Courage, risk taking
• Strong desire to succeed
• Knowledge of the business
• Funding
• Time and energy
• Planning
• Patience/perseverance

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The Viable Business
Costs
Revenue
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How Viable?
Revenue Costs
Revenue K Costs
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How big should K be?
K ? ROI
Net Profit
ROI
Total Assets
ROI Return On Investment
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Return On Investment (ROI)
ROI is defined as the ratio of net profit to
assets (or net worth) of an organisational
segment (company, division, business unit, or the
like).
ROI is a measure of financial efficiency that is
often used to set marketing objectives.
Please refer to ELE 31MEL lecture notes -
Marketing Arithmetic for Business Analysis
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Opportunity Cost

• Opportunity cost is what you give up as a
  consequence of your decision to use a resource in
  a particular way.
• Because of scarcity, use of a resource for one
  purpose means that some other use of that
  resource is lost.
• Opportunity cost of using a resource in a
  particular way is the satisfaction that would
  have been provided by its most preferred
  alternative and thus foregone use.

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Resources

• Time owner, hired staff, casual staff,
  contractors, consultants, etc.
• Money own money, bank loan, venture capital,
  shares, etc.
• Knowledge management, marketing, finance,
  technical, etc.
• Assets land, buildings, machinery, vehicles, etc.

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Costs of operating a business

• Trading
• Finance
• Premises
• Employees
• Selling
• Administration

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Trading

• Purchase of trading stock
• Inward freight, duty, handling and insurance
  costs
• Maintenance of plant, machinery, vehicles, etc.
• Depreciation of plant, machinery, vehicles, etc.
• Amortisation of plant, machine tools, etc.
• Vehicle registration, insurance, running costs,
  licences, etc.

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• Insurance - plant, stock, etc.
• Travelling expenses, including dealer conventions
  etc.
• Stock losses and wastage

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Finance

• Bank charges and interest
• Hire purchase interest
• leasing costs
• Interest on borrowings
• Factoring charges
• Discounts
• Return on invested capital

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Premises

• Rent / Lease
• Rates and taxes (municipal, land, water, etc.)
• Mortgage interest
• Registration of premises fees
• Maintenance of buildings
• Security patrol services

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• Burglar alarm - depreciation and maintenance
• Fire fighting equipment - depreciation and
  maintenance
• Insurance - building and public liability
• Cleaning, gardens, trees and plants, etc.

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Employees

• Wages, salaries, bonuses, overtime, etc.
• Holiday pay - annual, award or public holidays
• Long service leave provision
• Sick leave pay
• Fringe benefits
• Workers compensation insurance
• Additional public risk insurance
• Superannuation contributions

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Employees (Continued)

• Apprentices - trade school time and other
  training
• Staff training
• Staff welfare and recreational expenses, social
  clubs
• Clothing - uniforms, overalls, gloves, cleaning
  etc.
• Safety precautions
• Staff amenities - canteen, radio licences, etc.

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Selling

• Salaries and commissions
• Warehousing / Storage
• Packing
• Delivery
• Insurance

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Administration

• Directors fees
• Telephone, facsimile, Internet, and postage
  charges
• Tax administration
• Stationary and printing offices supplies
• Salaries and wages
• Staff amenities - canteen services etc.
• Accountancy charges etc.

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Administration (Continued)

• Consultants fees
• Solicitors fees and legal expenses
• Audit, internal and external
• Office equipment etc. - depreciation,
  maintenance, service charges
• Payroll tax
• Entertainment expenses

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Administration (Continued)

• Trade association subscriptions
• Donations to charities, local bodies etc.
• Electrical, gas, and other light and power
  charges
• Technical books, references, magazines etc.
• Market research
• Storage of files and records
• Advertising, including promotional gifts etc.

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Special Costs

• Insurance on goods held in trust, equipment,
  tools of the trade etc.
• Factory or shop registration, business name
• Licences for storage of inflammable liquids
• Purchase of hand tools
• Contractors wet time and location claim
• Scales or test equipment calibration fees
• Cranes - inspection fees and maintenance

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Cash Flow Forecasting

• Cash flow is a function of time.
• Inflow (revenue and other receivables)
• Outflow (materials, accounts payable, etc.)
• Buffer (cash in bank)

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Cash Flow Model
Your Business


Money in Bank
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Cash Flow Chart
Jan
Feb
Jul
Aug
Sep
Oct
Nov
Dec
Mar
Apr
May
Jun
Revenue Salaries Office Rent Insurance Telephone
Vehicle Light Power Stationery Advertising etc.
Total
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Useful References

• The Small business handbook how to start and
  successfully operate a small business, ISBN
  1-86350-004-9, Small Business Corporation (Vic.)
• How companies work, ISBN 0-725-10689-1, Nicholas
  Brash, Timothy Lindsey
• The Australian Taxation Office website

Note Please search for newer editions for the
above references
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General Business Topics
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Topics

• Business as a System
• Business Requirements
• Sources of Funds
• Cost Accounting Objectives
• Elements of Product Cost
• Fixed Variable Costs

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The Business as a System
Dividend
o
div
tax
m
Initial Capital
Individual Tax
Profit

B f()

y
w
p



Total Revenue
s
x
tax
Cost of business
Material Wages Services
tax
Company Tax
Group Tax
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Double Taxation System

• For the year ended June 1986, company profits
  were taxed twice.
• The first tax was at 46 cents in the dollar and
  was levied on the companys profits.
• The 54 cents in the dollar were available for
  distribution to the shareholders.
• The second tax was was levied on the shareholder
  at his or her personal tax rate.

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Tax Imputation System

• Under the old double taxation system, a
  shareholder at the top marginal rate of 60 cents
  in the dollar would have paid 32.4 cents out of
  the 54 cents dividend income.
• If the profits were distributed to shareholders
  all paying the top marginal rate of tax, the
  total tax paid would have been 78.4 cents,
  leaving 21.6 cents of income.
• Imputation system effectively abolished the
  double taxation and it refers to the provision
  that the company tax paid is imputed as a credit
  to the shareholder.

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Types of Capital

• Working Capital - Required to finance the
  day-to-day running of the business.
• Long-term Capital - Required to finance the
  purchase of assets which will, directly or
  indirectly, contribute to profit over a period of
  years.

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Sources of Funds

• Shareholders funds
• Loans from directors
• Bank overdrafts loans
• Trade other creditors
• Government grants
• Venture capital companies
• Other loans

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What is Venture Capital ?
Venture capital (VC) is the process of investing
private equity in companies, typically in early
stages of development, that are believed to offer
significant potential to grow substantially and
reward investors accordingly.
Ref. www.investorhome.com
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Objective of VC
The objective of VC is to generate high rates of
return over long periods of time. VC offers
institutional investors and high-net-worth
individuals high returns (historically better
than stocks) and strong diversification benefits
from very low correlation with other asset
classes.
Ref. www.investorhome.com
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Negatives about VC

• The major negatives of investing in VC are
• Long time frames,
• Lack of liquidity, and
• High management fees.

Ref. www.investorhome.com
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History of VC
Before 1946, individuals and families dominated
the VC markets. VC became a defined industry in
the 1950's, primarily financed by wealthy
individuals or syndicates. American Research
and Development was founded in the early 50's and
was considered the grandfather of modern
venture firms. The firm's 25,000 investment in
Digital Equipment multiplied into a stake in
excess of 100 million.
Ref. www.investorhome.com
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Venture Capital - Task for students
Conduct a search on the Internet for information
on Venture Capital and examples of Venture
Capital Companies. As an example, look at the
following web sites www.vcjournal.com.au (get a
free journal copy) www.brentwoodvc.com www.norwest
vc.com www.infon.com www.facvc.com Seek
answers for How do VC companies invest and in
what do they invest?
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Elements of Product Cost

• Direct material
• Direct labour
• Manufacturing overhead
• Indirect material,
• Indirect labour,
• Light and power,
• Repair and maintenance, and
• Depreciation of equipment, etc.

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Fixed Variable Costs

• Fixed Costs
• These are costs which do not vary with changes in
  the volume of production.
• Variable Costs
• These are costs which vary proportionately with
  the volume of production.

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Break-Even Analysis
Revenue
Area of profit
Loss Profit
Quantity of units produced and sold
Variable Cost
Break-even point
Area of loss
Fixed Cost
Revenue and cost
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Cost Accounting Objectives

• To measure, for profit determination purposes
• The cost of goods manufactured, or
• The cost of services performed
• To measure the cost and thus the Balance Sheet
  value of inventories, which include
• Raw materials
• Work in process
• Finished goods
• Store and supplies

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Cost Accounting Objectives - Continue

• To assist management in their planning and
  decision making by reporting costs relevant to
  decisions
• Targeted volume,
• Pricing levels,
• Make or buy,
• Purchase or lease, and
• Introducing or phasing out products, etc.

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Cost Accounting Objectives - Continued

• To assist management in monitoring and
  controlling costs in order to ensure that, as far
  as possible, management strategies and plans are
  implemented.
• In summary, cost accounting objectives cater for
• Requirements of financial accounting
• Management planning and control

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Important Note
When preparing your Business Plan, you are
expected to use the knowledge you gained in the
Legal Principals and Marketing for
Engineers. Students of ELE 41EIB, please refer
to your last year notes or the web site.
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Next weeks lecture 4 May

• Attendance is optional.
• Purpose is to review the contents of this lecture
  as they relate to your business plans.
• Answer any questions on this, or your current
  business planning.

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Thank you for your attention