Costing

Working out your basic costings is something that even the biggest businesses tend to ignore. For instance between 1958, when it was introduced, and the mid 70's the Austin Mini was sold at a loss because no-one had calculated how much it cost to make! The company that invented the wire free burglar alarm went broke after supplying every unit it made to a major DIY store because they lost £5.00 every time they made and sold a unit!

This sounds incredible but it's true.

Knowing how much it costs you to work helps you to decide whether or not to take on work, whether your business is viable and, ultimately, what you can sell at. This session is designed to help you to understand the different elements of cost and how to calculate them accurately. Later we will look at how to price your product or service in order to recover all the costs and make a profit and to understand the implications of discounting and increasing price

Before we start to look at the different types of businesses, let us consider the elements that go to make up the cost of the service, or product.

Types of Costs Incurred in Business

Materials

Bricks, Sand, Cement, Work in Progress

Stock bought in for resale

Subcontracted Labour used on a job by job basis

These are known as variable costs, cost of sale or direct costs and are only incurred if you get the job or, in the case of a retail shop, sell the product

Capital

Van, Vehicle, Fixtures and Fittings

Cement Mixer, Large Tools and Equipment

Hand Tools, Small Items of Equipment

These are capital costs and fall in to 2 categories Those which will have a value if you resell them (Van and Cement Mixer) and those which have little or no value (Hand Tools).

Overheads

Telephone

Advertising

Heat / Light

Rent / Rates

Accountant

Pension

Living Wage

Vehicle running

etc.

These costs are know as fixed cost, indirect cost or overhead and this is usually the area that most businesses get wrong, or miscalculate. These costs keep going whether you get work or not. Make a list of all of the expenses you will have to consider when you set up in business. Although 'Living Wage' is in this column it is not a tax deductable item and is simply here to help calculate costs.

There are several types of business

Those which sell time plus materials (can include: plumbers, electricians, joiners, designers, computer repair and servicing, etc.)

Those which sell, or hire, time, equipment or expertise (can include: accountants, dentists, solicitors, childminders, crèches, consultants, plant hire, etc.)

Those which buy and sell product (can include: shops, Internet sales, builders, manufacturers, etc.)

The first section of this programme deals with the first type of business and involves working out how to apportion direct, capital and indirect costs (see glossary) To continue to this example, simply click the underlined section, above. If your business is one where you are only selling time, expertise or hiring out equipment and you want to move on that underlined section now. If your business is a retail type business where you are buying and selling product and profit is based on how many you sell, rather than how long you work, then click that underlined section now.

Time plus materials

Imagine you are a builder and you've been asked to quote to build a wall. This is an example of the typical costs involved and how to apportion them to the job in order to find out what it will cost you to do it.

Please note: at this stage we are not looking at what you will charge. This will come later in pricing. To understand how we apportion them look at the diagrams below:

Materials

Bricks

Sand

Cement

Capital

Van

Cement Mixer

Hand Tools

Overheads

Telephone

Advertising

Heat / Light

Rent / Rates

Accountant

Pension

Living Wage

Vehicle running

Consumables

Small Hand Tools, Computer parts and other items that are bought as consumables or as repairs and renewals may be put into the overhead column. In order to give accurate costing figures work out how much you will spend on this type of item for a full trading year

Materials

Bricks

Sand

Cement

Capital

Van

Cement Mixer

Overheads

Telephone

Advertising

Heat / Light

Rent / Rates

Accountant

Pension

Living Wage

Vehicle running

Consumables

Depreciation

Other capital items may be 'depreciated' in other words each year they are worth less and less and if you put a sum of money in the overhead column, by the time they need replacing then your customers will each have paid a little towards the full cost of replacement. The typical allowance is 25% or a quarter of the value per year (see glossary)

Materials

Bricks

Sand

Cement

Overheads

Telephone

Advertising

Heat / Light

Rent / Rates

Accountant

Pension

Living Wage

Vehicle running

Consumables

Depreciation

Now that you have 2 columns you can calculate the cost per job. Let's say that the right hand column adds up to £12,000 for your estimated overheads for the year, you simply divide that by the number of days (or hours) that you are able to work and that will tell you how much it costs you per day (or per hour)

For example £12,000 per year is £1000 per month - if you assume 20 working days per month then it costs you 1000/20 = £50.00 per day to work.

If you were quoting to build a wall and you knew it would take you 2 days then you know it will cost you £100.00 plus materials to build the wall.

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Time Only

If you are selling time in the form of expertise, consultancy, training, childminding, etc. or hiring capital equipment (or even renting accommodation) on a daily / hourly basis then you will want to know how much it costs you to work per hour / day / week or month.

In order to calculate this you need to make a complete list of all the running costs and capital requirements of the business for a full year. In addition you need to know realistically how many hours / days you are going to be able to work at the things you customers will pay you to do ... In other words picking up supplies, chasing payments, writing quotes, going to the bank, travelling to and from clients, etc are not things people will pay you to do.

A general suggestion when calculating work hours (or days) is to assume there are 48 weeks in a trading year (allowing 2 weeks holiday and 2 weeks illness in any one year). Then deduct 1 day per week off your 'willing to work' days, since this will be needed for general business management and messing about. Then realistically estimate the number of hours per day that could be fee earning.

Again, be realistic .. the only person you can fool is yourself.

Refer to the diagrams below to see an example of how to calculate costs.

Capital

Vehicle

Computer Equip

Desks / Chairs

Small Tools

Overheads

Telephone

Advertising

Heat / Light

Rent / Rates

Accountant

Pension

Living Wage

Vehicle running

Consumables.

Small Hand Tools, Computer parts and other items that are bought as consumables or as repairs and renewals may be put into the overhead column. In order to give accurate costing figures work out how much you will spend on this type of item for a full trading year

Capital

Vehicle

Computer Equip

Desks / Chairs

Overheads

Telephone

Advertising

Heat / Light

Rent / Rates

Accountant

Pension

Living Wage

Vehicle running

Consumables.

Depreciation

Other capital items may be 'depreciated' in other words each year they are worth less and less and if you put a sum of money in the overhead column, by the time they need replacing then your customers will each have paid a little towards the full cost of replacement. The typical allowance is 25% or a quarter of the value per year (see glossary)

Overheads

Telephone

Advertising

Heat / Light

Rent / Rates

Accountant

Pension

Living Wage

Vehicle running

Consumables.

Depreciation

Now that you have 1 column you can calculate the cost per job.

Let's say that the column adds up to £12,000 for your estimated overheads for the year, we simply divide that by the number of days (or hours) that you are able to work and that will tell you how much it costs you per day (or per hour)

For example £12,000 per year is £1000 per month - if you assume 20 working days per month then it costs you 1000/20 = £50.00 per day to work. If you were quoting to carry out a project (or to hire some equipment) and you knew it would take you 2 days then you know it will cost you £100.00 to complete the project

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Costing for Buying & Selling Products

In order to calculate costing for retail (or any situation where you are buying and selling a product or service and profit is based on what you sell, rather than how much time you spend selling it, for example a restaurant, take away, etc.) you need to have an estimated forecast of how much you will sell throughout the year, and therefore what stock you will have to buy to achieve this.

This may appear to be difficult at first, however when you cover the section on Sales Forecasting it will become much clearer.

If we therefore assume that you have a fair idea of what and how much you will sell throughout the trading year and you know what you will be paying for it

Refer to the diagrams below to see an example of how to calculate costs.

Direct Cost

Stock

Capital

Fixtures & Fittings

Vehicle

Small Tools, etc.

Overheads

Telephone

Advertising

Heat / Light

Rent / Rates

Accountant

Pension

Living Wage

Vehicle running

Consumables.


Small Hand Tools, Computer parts and other items that are bought as consumables or as repairs and renewals may be put into the overhead column. In order to give accurate costing figures work out how much you will spend on this type of item for a full trading year

Direct Cost

Stock

Capital

Fixtures & Fittings

Vehicle

 

Overheads

Telephone

Advertising

Heat / Light

Rent / Rates

Accountant

Pension

Living Wage

Vehicle running

Consumables

Depreciation


Other capital items may be 'depreciated' in other words each year they are worth less and less and if you put a sum of money in the overhead column, by the time they need replacing then your customers will each have paid a little towards the full cost of replacement. The typical allowance is 25% or a quarter of the value per year (see glossary)

Direct Cost

Stock

Overheads

Telephone

Advertising

Heat / Light

Rent / Rates

Accountant

Pension

Living Wage

Vehicle running

Consumables

Depreciation

Now that you have 2 columns you simply add each of them up to get a total for Direct Costs (Stock) over the year and Overheads for the year.

Let's assume that the Direct Cost figure is £32,000 and the Overhead column adds up to £11,800 (for example). You then simply divide the Overheads by Direct Cost i.e. 11,800/ 32,000 and multiply by 100. This gives you a figure of 36.875% and tells you that you have to add 36.875% to the cost of every item to work out the true cost of buying it.

For example, let's say you buy a dress at £10.00 from the wholesalers. You then add 36.875% and you know it really cost you £13.69 when you take into account your overheads. If you sell it at less than £13.69 you will eventually go bust - Everything above £13.69 you sell it for is profit.

 

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