Cost accounting is a complex subject that specialist
accountants use to examine and report on business expenses
to ensure financial control. Such expert cost accounting
might involve absorption costing, marginal costing, break
even and variance analysis. Such specialist accounting
techniques are not usually available to the small business
as they lack a cost accountant.
The good news for small business is that the majority do
not need such specialist costing analysis as then
proprietor usually has intimate detailed knowledge of all
business expenses incurred. Or at least the small business
believes he has that knowledge.
In truth it is not until regular bookkeeping records are
produced that the small business can stand back and examine
the real effect of the business expenses on the
profitability of the business. And by virtually taking a
third party view of the costs and effect of those expenses
on profitability can the financial decision be taken to
improve profitability.
Producing accounts on a monthly basis using accounting
software suitable for the size and accounting experience of
the small business owner is the first step to improving
profitability. The second step is to review those accounts
and determine just which cost items can be changed.
Costs occur and behave in different ways. Some business
expenses may be regarded as fixed costs which others are
termed variable or semi variable costs. The impact of sales
volume increases or decreases variable costs and the
marginal gross profit produced while turnover has little
impact on fixed costs in the short and medium timescales.
Having produced a monthly profit and loss account and
started the accounting for profit review of the financial
figures it is useful to separate the nature of the expenses
into those that are fixed and those expenses which are
variable costs and those expenses which are semi variable
costs.
Fixed costs means the level of expenditure does not vary
with normal changes in sales volume in the short and medium
term at least. But being fixed does not mean the rice of
that expense cannot be reduced by examining both the value
for money obtained and whether that cost is necessary in
the first place.
Fixed costs of a small business might include such items as
rent and premises costs, insurance and indemnity premiums,
capital costs of fixed assets, administrative, legal and
professional fees. Another way to view what is and what is
not a fixed cost is to determine which costs are incurred
to provide the base operating facility of the business.
If by changing the base of the business or negotiating
better rates for those base expenses the fixed costs can be
lowered then the pressure on generating gross profit is
reduced. Fixed expenses may also contain such waste
expenditure and any non essential expenditure in this area
should be reviewed for potential elimination on the basis
that if it can be dispensed with without affecting sales
volume then chop out that expense as waste.
Variable costs depend heavily on the products or services
being provided but are essential the cost of goods and
services being sold. Often called direct costs the variable
costs of a business should be reviewed for ways to reduce
the unit cost either by sourcing cheaper supplies at the
same quality levels or negotiating more effective prices.
The volume of purchases can obviously affect the variable
cost and consideration may be given to placing regular
orders, higher volume orders or negotiating settlement
discounts.
Direct costs are perhaps one of the one most influential
cost areas in that the lower the direct cost that can be
achieved reduces the sales volume required to reach and
exceed the beak even point and also puts less pressure on
the fixed costs.
Semi variable expenses would be those items which the small
business makes definite decisions to buy depending upon the
requirements of the products and the level of volume
required. Many semi variable costs are dependent upon the
management decisions of the small business owner and are a
critical area in which the success or failure of the
business may depend.
Semi variable costs may include the advertising and
promotion costs of the business, perhaps the transport and
distribution costs, direct employees and goods or services
bought in to support the sales volume.
Each variable cost should be reviewed and a decision made
on whether value for money is being obtained. That review
should also examine whether the level of support the semi
variable costs provide to the achievement of financial
success is adequate, improvable or could be dispensed with.
Accounting for profit is the key area in which to examine
all costs. Accounting or bookkeeping software can be a
useful tool to identify the volume and levels of expense.
The nature and performance of each expenditure
classification should be subjected to the critical review
of the small business owner to generate either a higher or
safer financial performance.
----------------------------------------------------
Terry Cartwright, accountant and CEO at DIY Accounting,
designs accounting software http://www.diyaccounting.co.uk/
on excel spreadsheets providing complete single and double
entry bookkeeping systems
http://www.diyaccounting.co.uk/bookkeeping.htm
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