1. Workshop #4
Business Finance
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2. Direct Costs Overhead Costs
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3. 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.
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4. 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.
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5. 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.
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6. 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.
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7. 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
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8. 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.
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9. Direct/Product costs per cone
Cost Structure
Direct/Product costs per cone
Material cost
Labor cost
Other costs
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.
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10. Annual Overhead Costs Cost Structure (cont’d) Manager’s salary $60,000
Property Taxes ,000
Utilities ,000
Maintenance ,000
Insurance & Misc ,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.
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11. 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
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12. 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
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13. Cash Flow (Money in – Money out) Cash Flow
How money moves in your business. Emphasize the importance of a positive cash flow.
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14. 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
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15. 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
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16. 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.
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17. 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%
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18. Questions?
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