Business Planning: Budgeting and Breakeven Analysis
Budgeting in business is similar to budgeting in your personal life, but it has the added dynamic of variable streams of funds and ever-changing expenses. It does not, however, need to be difficult. In fact, if you spend time building a budgeting model (as will be seen in this chapter), you can have great budgets with minimal time investment.
The Budgeting Process
In accounting, there is a concept called Cost Volume-Profit Analysis. This is an intimidating title that simply means this: when your sales go up or down, some of your expenses will change. If you consider things like electricity, payroll, cost, etc., it makes sense that if you sell more of something you will likely have more costs. Right? Well, this takes that concept just a bit farther but is not that complicated.
Cost Volume-Profit Analysis
“Cost Volume Profit Analysis is a means of predicting the effects of changes in costs and sales levels on the income of a business” (Larson).
Types of Costs
Fixed costs are those costs that are the same regardless of your sales volume (See Semi-Variable and Stair Step Costs for exceptions). Rent is a good example of a fixed costs in that your rent stays the same if you have zero sales or numerous sales.
Variable costs are those costs that are associated with your volume of sales. An example of a variable cost would be the parts needed to make a specific item such as computer chips in a computer or sugar in a soda bottle. The more items you produce, the more of these costs you will incur.
Semi-Variable and Stair Step Costs
Some costs do not fit the description of either a fixed or variable cost, as they are a blend of the two. A good example of this is utilities. Often with utilities you will pay a minimum amount for service plus a variable amount for kilowatts used. This makes it a semi-variable cost.
Earlier we looked at rent as a fixed cost. However, what happens when you are producing your maximum number of items in the space you are renting? You would, naturally, have to acquire more space and that would increase your rent. This is called “Stair Stepping” costs. Stair Stepping is when you have a cost that is fixed for a range of sales but takes a step up in costs at certain levels, as with what happened in the rent example.
Breakeven
So often, new business owners read the “how-to” and see things like Break Even Analysis and glaze over. Similar to Cost Volume Profit Analysis, the name is more intimidating than actually doing the analysis. Breakeven, in simplest terms, is how many units a company must sell (in units or dollars) in order to break even, covering all fixed and variable expenses. It is important to know your breakeven as it gives
you realistic estimations of how much your sales need to be to start making a profit. In fact, a breakeven analysis is one way to know whether you should go forward with a project.
There are many uses for the breakeven analysis besides your initial need to see what your sales volume needs to be. One of the primary uses for a small business is to estimate the volume of sales needed to produce a targeted profit. This is important for two main reasons. The first reason is that you are in this to make a profit, not break even. You can stay at home and break even, so why work and take risk just to stay the same economically? The second reason is to see how much flexibility you may have in lowering or increasing sales price or to see the effect of changes in cost of materials or labor.
Using the techniques from lecture notes develop plan for Budgeting and Breakeven Analysis for a business concept selling shoes and appraisal .
There is no assumption for the Business plan. According to the lecture note above develop a Budgeting and Breakeven Analysis for Any Business plan.