HA1 Task 5 – Budgets

Variable Costs – Gross profit and gross profit %

Variable costs are those expenses in your business that increase or decrease with the level of your sales. For instance, if you sell hamburgers, your variable costs would include the cost of the meat, the buns, condiments as well as packaging. As a general rule, your variable costs can always be expressed as a percentage of your sales. For instance, if the cost of buns, meat, etc. for a hamburger that sells for £1 is 60p or 60%, then you can assume that if you sell ten hamburgers or £10 in sales that your variable costs will be 60% of that or £6.

With this data you can figure your gross profit and gross profit percentage.

Sales - Variable Costs = Gross Profit

£1 – 60p = 40p

Gross Profit ÷ Sales = Gross Profit Percentage

40p ÷ 100p = 40%

This is a very important concept because it allows us to determine the net effect of increases and decreases in sales.

Fixed Costs – Net profit

Fixed costs are those which you will incur whether you have any sales or not. These would include such items as rent, utilities, certain labour, insurance, etc.

Unlike variable costs, fixed costs do not increase or decrease with changes in sales. Therefore, the greater your sales, the less of an effect your fixed costs will have on your net profits.

Here's how to determine net profit:

Gross Profit - Fixed Costs = Net Profit

Fixed costs are only valid within a certain range of sales or activity. If sales exceed that range, fixed costs will jump to a new level. For example, you may be able to produce 100 hamburgers per hour with one employee; however, to produce more than that you would have to hire more help.

Break Even Point

The break-even point is, as the name implies, the level of sales where you neither make money nor lose money.

It is the level of sales where the gross profit is the same as the fixed costs. Using our hamburger example, we will assume fixed costs are £400, we have £1,000 in sales and our gross profit percentage is still 40%. Since we sell hamburgers for a £1 each, we must sell 1000 hamburgers to break even.

The break-even point is important for two reasons: one, it lets us know what volume we must sell to keep from losing money. And two, with a little modification, it will also tell us how much we must sell to produce a given amount of net profit.

Monitoring

Once you have set up the budget, compare it to the actual figures every month, to look for differences and establish why they are there.

Adjust expenditure or sales efforts as you go along, to bring the next group of numbers in line with the budget.