Workshop #4 Business Finance © Career Partners, Inc. 2015

Direct Costs Overhead Costs © Career Partners, Inc. 2015

Direct or Product Costs In a business that makes a product, direct or product costs are those costs directly associated with making the product. Examples are cost of materials to make the product, cost of labor to make the product and other costs directly associated with making the product but not part of the product. In a service business, direct costs are those costs directly associated with supplying that service. Examples are costs of the people supplying the service, automobile or truck costs and gasoline costs if it is a delivery company. The total of these costs will change depending on the volume of service or the number of products sold. © Career Partners, Inc. 2015

Overhead Costs In businesses that make a product as well as in service businesses, overhead costs are those costs that a business would have no matter what the amount of sales it has of its products or services. Examples: salaries and benefits of managers insurance utilities taxes accounting legal costs These costs will not change based on the volume of service revenue or number of products sold. © Career Partners, Inc. 2015

Direct Cost of an Ice Cream Cone E-Squared Ice Cream Co. Direct Cost of an Ice Cream Cone Material cost ?.?? Labor cost ?.?? Other costs ?.?? Total direct cost ?.?? Apply the concept of direct and overhead costs to an ice cream cone. The direct costs such as material costs (ice cream, cone, toppings, etc.) with the labor costs (i.e. your sales/serving staff) and other costs (napkins, plastic spoons, etc.) are added together to tally your total direct costs. Where do you get this information? If you had past records you could use those, but even that will not always be 100% accurate – many times it is just an educated estimate. © Career Partners, Inc. 2015

Material Costs Cone $0.10 Ice Cream $0.50 Napkin $0.02 Sprinkles $0.04 Cost per Cone Cone $0.10 Ice Cream $0.50 Napkin $0.02 Sprinkles $0.04 Material Cost per cone $0.66 This is just an example of different types of material costs you may incur in an ice cream shop – at this point, ask students if they can think of any more and ask for volunteers. © Career Partners, Inc. 2015

Labor costs for a server Assume: Hourly rate incl. benefits = $9.85 Avg. worker sells 125 cones per 8-hr. day Now calculate the labor cost per cone: 8 hours x $9.85 = $78.80 Labor costs include a lot things you might not think about – other than an hourly salary/pay. Are you offering benefits such as health care, dental, etc. – what are the laws.? What about paying taxes? Those all need to be combined together to get the labor cost – you take that and divide by the number of cones they sell during the time they are working. $78.80 / 125 cones = $0.63 Labor cost per cone $0.63 © Career Partners, Inc. 2015

Other Costs Disposable rubber glove $0.05 Cost per Cone Other costs per cone You need to figure out what other direct costs are incurred in the business – gloves, napkins, etc. and total those. © Career Partners, Inc. 2015

Direct/Product costs per cone Cost Structure Direct/Product costs per cone Material cost 0.66 Labor cost 0.63 Other costs .05 Total direct/product cost per cone $1.34 Adding them up give you – your total product costs per cone. Remember this is what it costs YOU to provide the cone to the customer. © Career Partners, Inc. 2015

Annual Overhead Costs Cost Structure (cont’d) Manager’s salary $60,000 Property Taxes 5,000 Utilities 6,000 Maintenance 2,000 Insurance & Misc. 2,000 Total annual overhead costs $75,000 Then you need to figure out your overhead costs – remember these occur no matter how many cones you sell – so if you sell 5 or 5,000 cones, you still have these same overhead costs. Overhead costs per cone will change depending on how many you sell. The more you sell the less your overhead cost per cone. © Career Partners, Inc. 2015

Cost Structure (cont’d) How many cones are you going to sell each year? This will determine what your total direct costs will be for the year. Let’s assume that we are going to sell 75,000 cones. What then would be the direct costs for these cones? Now we have to do a little math to figure out how to distribute the overhead cost – over the year and through each cone we sell. 75,000 cones X $1.34 per cone or $100,500 © Career Partners, Inc. 2015

Cost Structure (cont’d) This will show on your P & L as follows, assuming you sell 75,000 cones at $2.50 per cone: Sales $187,500 Direct Costs $100,500 Gross Profit $ 87,000 If we sold fewer cones – what would happen to the price per cone? Expenses/OH $ 75,000 EBITD $ 12,000 © Career Partners, Inc. 2015

Cash Flow (Money in – Money out) Cash Flow How money moves in your business. Emphasize the importance of a positive cash flow. © Career Partners, Inc. 2015

Cash Flow Cash In if sold at $2.50 per cone Cash out Number of Cones Sold 50,000 75,000 100,000 Cash In if sold at $2.50 per cone $125,000 $187,500 $250,000 Cash out product cost of $1.34 $67,000 $100,500 $134,000 Overhead costs of $75,000 Cash out $142,000 $175,500 $209,000 Net (cash in less cash out) ($17,000) $12,000 $41,000 © Career Partners, Inc. 2015

Characteristics of Venture Capital What is Venture Capital? Characteristics of Venture Capital Private equity capital Early stage High growth potential Potentially high “Return On Investment” -- ROI -- So what does it all mean for E-Squared? When you have a business and want to expand or you want to start a new business you will need money – i.e. capital. You can try banks, you can try other places or you can try to get a venture capitalist to partner with you on this adventure. For purposes of E Squared, venture capital is your only resource. Venture Capitalists are typically business people who are willing to invest (i.e. give you money) for a portion of your company. They can help you with their connections and business experience. But in order for you to attract an investor of any kind, you have to prove the ability of your company to make a profit. They are not going to invest unless they are going to make money on their money. VC investments Cash in exchange for company shares © Career Partners, Inc. 2015

ROI = Annual Profit / Investment Return on Investment Return on Investment Usually called ROI ROI = Annual Profit / Investment The annual profit made on an investment is called Return on Investment. For investors to be convinced of investing in your company they will want to know when the company can be expected to make a profit and how much. This stream of profit is used to determine their return on investment on paper. For an investor to realize the actual return on the investment, he or she must receive dividends or sell some or all of their shares of the company’s stock. © Career Partners, Inc. 2015

Suppose you invest $10,000 in the stock of a startup company. ROI Suppose you invest $10,000 in the stock of a startup company. What is your ROI if you receive dividends of $1,500 per year? 15% What is your approximate ROI if you sell your stock for $16,000 after 3 years? This is to make sure that the class understands that ROI is ANNUAL return (not total return). Ask the class for answers to each of the 2 questions. Have them explain the answer before showing the correct answers. The 2nd example is simplified to get the concept across. The true ROI after the 3-year period is something less than 20%. 20% © Career Partners, Inc. 2015

Questions? © Career Partners, Inc. 2015