Examples of fixed costs:
- Rent and rates
- Depreciation
- Research and development
- Marketing costs (non-revenue related)
- Administration costs
Variable costs are those costs which vary directly with the level of output. They represent payment output-related inputs such as raw materials, direct labour, fuel and revenue-related costs such as commission.
A distinction is often made between "Direct" variable costs and "Indirect" variable costs.
Direct variable costs are those which can be directly attributable to the production of a particular product or service and allocated to a particular cost centre. Raw materials and the wages those working on the production line are good examples.
Indirect variable costs cannot be directly attributable to production but they do vary with output. These include depreciation (where it is calculated related to output - e.g. machine hours), maintenance and certain labour costs.
Semi-Variable Costs
Whilst the distinction between fixed and variable costs is a convenient way of categorising business costs, in reality there are some costs which are fixed in nature but which increase when output reaches certain levels. These are largely related to the overall "scale" and/or complexity of the business. For example, when a business has relatively low levels of output or sales, it may not require costs associated with functions such as human resource management or a fully-resourced finance department. However, as the scale of the business grows (e.g. output, number people employed, number and complexity of transactions) then more resources are required. If production rises suddenly then some short-term increase in warehousing and/or transport may be required. In these circumstances, we say that part of the cost is variable and part fixed.
Cash flow forecast
Creating a cash flow forecast doesn't need the skills of an accountant - it's a case of being methodical and remembering to include all the relevant information.
How to construct a cash flow forecast
A cash flow forecast is best laid out as a numerical table with groups of rows (representing items of income and expenditure) and columns (one for each week or month to which the forecast pertains). Note that your figures should include all VAT you plan to charge or expect to be charged.
Set out your table as follows (on a computer spreadsheet such as Excel or with a pen and some graph paper):
- Create a row for each source of income. You'll probably have a row for sales, another for grants or loans and any personal funds you intend to inject during the relevant period.
- Underneath this, create a row for each source of expenditure (you may wish to group related items such as office expenditure or salaries). Your list of outgoings will probably be long, and your list of income sources much shorter.
- Decide how long your forecast will cover. Use a column for each month if your transactions are mainly monthly, or a column for each week if the transactions will be mainly weekly.
- Group all your income rows at the top and sub total, to obtain an estimated total income for each month (or week). Now do the same for your outgoings. Your cash flow forecast for each month will show your income less your expenditure. Software like Excel lets you adjust figures, profit margins and dates to see different scenarios.
- Double-check your figures manually if using a computer to ensure you haven't made any mistakes. It's also worthwhile getting a trusted friend or paying for a professional accountant to check your figures.
- Make sure you allow for every outgoing, including VAT payments, and take care to enter the amounts in the months you expect to pay or receive them. Be realistic about how long your customers will take to pay, and always err on the side of caution - your income will always be less than you hope, and your costs higher.
Profit and loss account
Your profit and loss account shows just how profitable (or not) your business has been in a financial year.
Turnover minus costs
The profit and loss account concerns itself with your turnover (the total amount of all sales not including VAT) and the cost of sales (money paid to your suppliers for services or goods).
You subtract the cost from your turnover to arrive at a gross profit (your revenue) from which all other costs to your business, such as salaries and rent are subtracted. Once you have deducted all your costs from your gross profit you are left with your net profit or net loss. Any tax you have to pay is based on this final, net figure.
Preparing your profit and loss account
You can prepare your profit and loss account by yourself, perhaps with the help of a bookkeeper. If your company is of a reasonable size and the process is more involved, you might need a qualified accountant to help you prepare and, if necessary, audit your accounts.
Balance sheet
As its name suggest your balance sheet balances two different fiscal elements, and it has to accord with other financial information produced for your business.
What a balance sheet includes
The elements of your business that will need to be included in the balance sheet are:
Assets - the balance sheet summarises all your business assets. Assets include anything your business owns such as buildings, cars, and equipment and stock. It will also set out cash in hand and at the bank, as well as all monies owing to you by your debtors. All these elements are added together to give your total net assets at a particular date.
Business liabilities - Below your assets you will list your business liabilities. These will include the total monies you owe to suppliers and other creditors including your bank, utility companies and HM Revenue and Customs.
The liabilities of your business are then subtracted from your total assets to give your business a net worth - the value of your business in terms of shareholders' funds.
Reconciliation
Different forms of company will have their balance sheets laid out slightly differently. However, the purpose of all balance sheets is to give a statement of net worth at any point in time (usually the financial year-end). The balance sheet is then reconciled with the, which concerns itself with the trading history of one particular financial year.
