Fixed Vs Variable Expenses

FIXED V/S VARIABLE
EXPENSES
DR. T.K. JAIN
24/12/09 AFTERSCHOOOL CENTRE FOR SOCIAL ENTREPRNEURSHIP
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.
Identify fixed and variable
100 200 300 400 units
raw material 1000 2000 3000 4000 variable
wages 1000 2000 3000 4000 variable
power 1000 2000 3000 4000 variable
direct or prime cost
overheads (indirect)
salary 20000 20000 20000 20000 fixed
rent 20000 20000 20000 20000 fixed
sales related expenses
commission 1000 2000 3000 4000 variable
Fixed Operating Costs
Fixed operating costs must be paid whether
or not the business makes any sales.
Utilities
 Salaries
 Advertising
 Interest
 Insurance
 Rent
 Depreciation (method used to “expense”
expensive pieces of equipment)
Contribution Margin
How to calculate contribution
Contribution = sales – variable cost per unit
quality improv
mass production
tailor made
aftersales services
sales price 10 15 6 18 18
variable cost 3 9 2 13 8
contribution 7 6 4 5 10
Average Contribution
Margin
A business selling a variety of products can
use average COGS to determine an average
contribution margin.
Economics of One Unit
Depreciation Makes Records
More Accurate
 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.
Insurance Protects
Business
Buy insurance to protect your
business from:
 Fire and other natural disasters
 Theft
 Liability (lawsuits)
Basic Coverage for Small
Business
Required by most states:
 Workers’ Compensation
 Disability Insurance
 Auto Insurance
Premium: monthly payment on insurance policy
Deductible: amount of loss you agree to cover
Lower deductible = higher premium

Lying About Your Product Is
Fraud
 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.
Fixed Operating Costs can be
Dangerous to a Business
 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.
Start-Up Investment
 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
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.
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.
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.
Receipts and Invoices
 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.
Open Business Checking
Account
 Avoid using cash for business: Use
checks, get receipts. Keep a paper
trail.
 Deposit money from sales in checking

account right away.
“Cash Only” Accounting
 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.
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.

Fixed Vs Variable Expenses

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Fixed Vs Variable Expenses

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FIXED V/S VARIABLE

DR. T.K. JAIN

1. Cost of goods sold (COGS)

2. Other variable costs

 Subtract 25% of the computer’s cost

Lower deductible = higher premium

 Companies that sell products/services that

 Keep at least 3 months fixed costs as a cash

 Change fixed costs to variable costs

Start-Up Investment ($1,000)

Tells investors how long it will take

Keep good daily records of cash inflows and

 Deposit money from sales in checking

 Each entry on left side of journal must

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