fixed costs

Understanding Fixed, Variable And Semi-Variable Costs

In the world of accounting and bookkeeping, there are three different types of costs – fixed, variable and semi-variable. Understanding these costs can help you better grasp how your money is spent. They can also be used to project your expenses, create a budget, and develop revenue targets for your business.

Fixed costs

Fixed costs are the simplest of the three. They don’t change, regardless of your business activity, so no additional calculations are needed. Examples of fixed costs include rent/mortgage, insurance, salaries, interest payments, property taxes, and depreciation/amortization.

Variable costs

Unlike fixed costs, variable costs do increase or decrease with your business activity. Some examples are direct materials, production supplies, shipping costs, merchant fees, and billable wages.

Direct materials, production supplies, and shipping costs are often associated with manufacturers that produce goods and transport them to where they’re sold. In this scenario, the more goods a factory produces and ships, the more they’ll have to spend on materials, supplies, and transportation. 

When you accept credit cards or use payment processors, a small percentage of each sale goes to the bank or processor for facilitating the transaction. These are also a variable cost since the amount you pay in merchant fees depends on your sales.

Billable wages are often paid to contractors for hours worked or specific projects. An example might include hiring a lawyer to review a contract, which is an expense directly associated with business activity.

Semi-variable costs

Semi-variable costs consist of both fixed and variable costs. Part of the cost stays consistent (often a base cost) and part fluctuates with business activity. Examples include commission payments and overage charges.

Commissions are a semi-variable labor costs. They are usually percentages of sales that are paid to the employee who made the sale. In these cases, the salesperson earns a consistent base pay, which is a fixed cost. But their commission pay is variable since it’s dependent on the business’s sales, so when it’s combined with their base pay, you have a semi-variable cost.

Overage charges are additional fees that are levied for using too much of a service. An example of this is being charged a higher rate by your internet provider after exceeding your monthly bandwidth allowance. If the uptick in internet usage was associated with business activity, then it's a semi-variable cost.

Understanding your costs will help you create realistic goals for your business. If you would like to learn more about how BookKeeping Express (BKE) can help you track your costs and manage your bookkeeping, contact us today.

How To Create A Budget That Can Be Your Business’s Roadmap

By Lauren Crum  Email Lauren

Some accountants compare a business’s budget to a roadmap or GPS directions. They use this analogy because your budget guides you towards your goals. If you don’t have a budget, your business probably won’t get to where you aspire it to be.

Now is the time to create your budget for 2016. The first step is to estimate your revenue for the coming year. The easiest way to do this is to take your sales from 2015 and incorporate price increases and trends you expect to encounter in 2016. The estimate you develop will be your target revenue for the year. It should be ambitious but also realistically achievable.  

The next step is to project your operating costs. These can be pulled directly from your profit and loss statements (P&Ls). Costs are either fixed, variable or semi-variable. Fixed costs will remain the same whether sales rise or fall so they are the easiest to incorporate in your budget. Some examples of fixed costs are rent, depreciation, and insurance.

Variable costs are completely dependent on sales. Some examples are royalties, labor costs and manufacturing costs. You can calculate these costs as a percentage of prior year sales when creating your new annual budget.

Semi-variable costs are fixed to some degree, but also increase with sales. An example of this is overtime pay. Semi-variable costs are the hardest of all the expenses to project so it’s a good rule of thumb to always be conservative when estimating.

Once you subtract your projected operating expenses from your estimated sales, you’ll arrive at your projected profits for the year. With these estimates, you can plan for the coming year and make important decisions like whether you can purchase new equipment, move to a bigger location, add staff, or give your employees bonuses or raises.

A budget should be created at least every year. Most budgets are divided into 12 months and have blank columns next to your estimates that can be filled in with actual results as the year progresses. You may want to consult an accountant when preparing a budget or you can attempt it yourself using software or online resources (Microsoft offers a number of resources for creating a budget). Just remember that it's important to use realistic figures and make adjustments throughout the year.