Small business e-School

Identifying and Managing Operating Costs (Expenses)

The standard Profit and Loss financial reporting format is as follows: -

Costs in business occurs into two distinct sections of the financial profit and loss statement.

COST OF GOODS SOLD (sometimes called Cost of Sales) occurs “above” the gross margin line (gross profit) and includes raw materials, direct labour of production and in finished goods (inventory). 

This classification of cost is that which must be incurred in order to generate sales revenue. It is the ‘cost of provision’.

Expenses or ‘running costs’ are costs, which are not directly involved in producing goods or services for sale and fall into two categories;

FIXED COSTS are incurred REGARDLESS of whether sales are made or not.  These costs include items such as rent, insurance, loan interest, hire purchase and lease payments, superannuation, non-direct wages, local and federal taxes.  These costs must be paid when they fall due for payment and have no direct bearing on the revenue generation.

NON-FIXED (or Variable) COSTS are those costs that the business incurs mostly to generate the sales thrust and to effectively operate the company.  Their payment is generally more discretionary with respect to commercial influence and timing.  These costs include advertising, utilities, telephone, computer consumables, stationary, professional fees, salaries and administration costs, office consumables, periodicals, motor vehicle expenses, travel, entertainment etc.

The accurate identification and timely recording of costs on a monthly basis is critical for budgeting and cash-flow forecasting purposes. 

Exercises

It is suggested that you print this page and write your answers on the printout.  Once you have completed the exercise, view the corresponding answer page to assess how you have gone.

1.  For each of the following cost items, indicate with an (X) which cost category it belongs to: -

C O S T   C A T E G O R Y

Direct Cost of Goods

Fixed Expense

Non-fixed Expense

Superannuation

Brochures

Electricity

Industry subscriptions

Laminate board 2400 X 1200

Accounting fees

C

Router operator labor

O

Hire purchase for glue table

S

Travel expenses

T

Fork lift hire

Bank charges

I

Rates

T

Staff training

E

Protective clothing

M

Waste disposal

Fringe Benefit Tax

Workers Comp. Insurance

Depreciation

Subcontractors

Computer Consumables

Repairs and Maintenance

2.

____________________ costs are costs which have a direct bearing on the outcome of sales results.

3.

COGS are costs which usually occur above the ____________________ in a profit and loss statement.

4.

Accurately identifying and forecasting costs is an essential management role for developing both  ____________________ and ____________________ for the business.

5.

Freight costs should be placed in same cost category as travel expenses. [True]/[False]

6.

Direct factory labour should be placed in same cost category as sales wages. [True]/[False]

7.

Gross Profit less Expenses equals ____________________.

8.

Gross Profit is considered “real income” because: -

(a)  It is the largest profit number

(b)  It is the same as cash in the bank

(c)  It is the amount of money available to run business operations

(d)  It is always much higher than Operating Profit

9.

Advertising is a fixed cost because we have to advertise to make sales. [True]/[False]

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