Cost accounting is a complex subject that specialized accountants use to audit and report business expenses to ensure financial control. Such professional costing can include full costing, marginal costing, cost recovery, and analysis of variance. Such specialized accounting techniques are not typically available to small businesses because they lack an accountant.
The good news for small businesses is that the majority do not require such specialized cost analysis as the owner usually has accurate and detailed knowledge of all business expenses involved. Or at least the small business thinks he has that knowledge.
In truth, only after regular accounting records are prepared can the small business step back and examine the actual impact of business expenses on the profitability of the business. And by having a third party virtually view the cost and impact of those expenses on profitability, the financial decision to improve profitability can be made.
Creating accounts on a monthly basis using accounting software appropriate for the small business owner’s size and accounting experience is the first step to improving profitability. The second step is to review these accounts and determine which cost items can be changed.
Costs arise and behave differently. Some business expenses can be considered fixed costs, while others are referred to as variable or semi-variable costs. The impact of sales volume increases or decreases variable costs and the marginal gross profit achieved, while sales have little impact on fixed costs in the short and medium term.
After you’ve prepared a monthly income statement and started accounting for the profit review of financial metrics, it makes sense to break down the type of expenses into fixed, variable, and semi-variable expenses.
Fixed costs mean that the level of expenditure does not change with normal changes in sales, at least in the short and medium term. However, being fixed does not mean that the rice of these costs cannot be reduced by examining both the value for money achieved and whether these costs are even necessary.
A small business’s fixed costs can include items such as rent and occupancy, insurance and indemnity premiums, capital costs of fixed assets, administrative, legal, and consulting fees. Another way to see what is and isn’t a fixed cost is to determine what it costs to provide the company’s basic operating facilities.
If fixed costs can be reduced by changing the business basis or by negotiating better rates for these basic costs, the pressure on generating gross profits will be reduced. Fixed expenses may also include such waste expenses, and any non-essential expenses in this area should be reviewed for possible elimination on the basis that if they can be dispensed with without impacting sales volume, those expenses will be cut out as waste.
Variable costs depend heavily on the products or services provided, but are a significant cost of the goods and services sold. A company’s variable costs, often referred to as direct costs, should be reviewed for opportunities to reduce unit costs, either by sourcing cheaper supplies at the same quality level, or by negotiating more effective prices. The purchasing volume can obviously affect the variable costs, and it can be considered to place regular orders, higher volume orders or to negotiate settlement discounts.
Direct costs are perhaps one of the most influential cost areas, as the lower the achievable direct costs reduce the sales volume required to reach and exceed the beak-even point and also put less pressure on fixed costs.
Semi-variable spends are those items that the small business makes specific purchasing decisions to purchase based on the needs of the products and the volume required. Many semi-variable costs depend on the small business owner’s management decisions and are a critical area in which the success or failure of the business can depend.
Semi-variable costs may include the company’s advertising and promotional costs, possibly transportation and distribution costs, direct employees, and goods or services purchased to support sales volume.
All variable costs should be reviewed and a decision made as to whether value for money is being achieved. This review should also consider whether the support provided by the semi-variable costs to achieve the financial success is adequate, could be improved or is not necessary.
Profit accounting is the key area where all costs are examined. Accounting or bookkeeping software can be a useful tool to determine the volume and amount of expenses. The nature and performance of each expense classification should be subject to the critical scrutiny of the small business owner to achieve either higher or more assured financial performance.