Running a business means setting clear goals that you would like to achieve as a business owner. Whether that is to provide services or manufacture products, you must have a defined target and strive to reach it. Certainly, one of your goals should be making money i.e making a profit, since there is no future in a business that is repetitively not profitable. Focusing merely on the sales you are generating won’t give you the full picture. Hence, the way to success and money is through knowing your costs.
In this blog, I am going to explain the different types of costs and how they behave in different circumstances.
The importance of knowing your costs
The sales that you make are not your profit in the business precisely because of the costs you have. Once the end customer has paid you for the product or service that you offer, the money you receive needs to cover the expenses that you encountered in the process of production. Now, these expenses are what I call costs. By knowing your costs, you will know what you are left with from the sales. In other words, you will know how much of your income makes up your profit.
You might have amazing products, customer support, and marketing strategies, but in the end, it all comes down to the numbers. Running a business means planning, and you need to plan your costs as well. In order to excel in the management of your money, you need to focus on several aspects which include:
- Current and future profit
- Sales price
- Target customers
- Allocation of funds
What influences your costs?
Each business deals with different types of costs depending on what they are offering to their customers. So, the activities that your business does will determine the underlying costs.
Here are a couple of examples to clarify this statement. Let’s say you are in the manufacturing sector and you own a shoe factory. The amount of your costs would depend on the product orders and the production. The more products you make, the greater the cost would be. You will need more materials, maybe even more employees to deal with the product demand in time. On the other hand, if you are a consulting firm, the cost would depend on the clients you have, the number of workshops you deliver, and the time required to complete them.
Knowing your costs – how do costs behave?
Costs include various expenses a business can face, such as costs for supplies and materials, equipment, wages and salaries, taxes, marketing costs, and many more. However, the nature of each cost is idiosyncratic. Each cost has a characteristic behaviour, and for that reason, there are 4 main categories:
- Fixed costs
- Stepped fixed costs
- Variable costs
- Semi-variable costs
Fixed costs, as the name suggests, are the costs that do not alter in any way, regardless of the activity of your business. Whether you are currently working at full speed, or not working has no effect on your fixed costs. For example, if you have a barbershop, no matter the number of clients you have per month, you still need to cover the expenses for rent, salary, and the like.
In the business world, people also call these costs non-controllable or unavoidable, and they include:
- Wages and salaries
- Leasing charges
Stepped fixed costs
As a subgroup of fixed costs, there are stepped fixed costs. They refer to the fixed cost that might alter over time due to some changes in your business. An example of this would be having to hire additional staff in order to accomplish the scope of work, which would result in additional costs for the company.
The second group of costs is variable costs, also known as controllable or avoidable. These fluctuate according to the activities performed at a certain point in time.
For example, if you own a restaurant, a variable cost would be the money you spend to buy the ingredients you need to prepare your meals. And it would depend on the number of customers you have.
Other examples of variable costs are:
- Wages and salaries – paid on a project basis, or hourly rate, etc.
- Sales commissions.
There are costs in business that are neither fixed, nor variable, but a combination of the two. This means they can be divided into two separate sections. A good example of this is telephone costs. The fixed cost aspect refers to the purchase of the unit. Even if you don’t use your phone, you will still need to pay for it. On the other hand, the variable aspect of the cost is when it comes to making the actual calls. The more calls you make, the bigger the cost.
In conclusion, each business has to deal with various costs. They can be grouped into two sections: fixed or variable costs. Knowing your costs and how they behave can help you manage your funds more efficiently. So, if your goal is to make a profit, make sure you pay attention to this aspect of your business.
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