Costs are simply an amount paid or given up in return of something. In simple language, when you pay something either money or kind in return of anything then that will become a cost for you.
For Example, you paid $10 for buying a chips packet from a store. In this case, $10 will become to cost to you for purchasing the chips packet.
Since in return you are getting a chips packet worth $10, it will be a win-win situation for both. You will lose your money and on another side then the person will lose chips packet worth Rs. 10.
Business Costs: Costs For Running The Business
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In the business, costs are simply a monetary valuation of various factors like Salary Paid to Employees, Raw Material Consumed, Various Utility Consumed and Opportunities forgone for producing a particular product.
When all these factors put together it becomes costs for running the business and this cost will get recovered by selling the produced product in the market for money.
The consumers will buy your product for the money and thereby you will get rewarded for incurring the costs.
Have you ever wonder? Why the cost and price keep on fluctuating?
This is because the value of the exchange is not static in the market. If a seller pre-receive any scarcity in the resource then they will increase the prices (assuming the cost will rise) or vice versa.
But, this kind of fluctuation will not have any impact on the market. The people will continue doing the transaction as far as they are getting more value then they are giving up.
But, a question may arise, how to measure this? How to arrive at the cost incurred per product?
Note: All the calculations given below are only for an understanding purpose. We have twisted many formulae so as to ensure that the entrepreneur running the business could understand it. For exact formula and calculation, please contact your accountants.
Very Simple. All you need to do is just divide the total cost paid for using the resources by revenue received from selling the products.
But, to be more precise, it is always advisable to deduct the cost of goods sold from the Sales revenue and thereby divide the same with price received from selling products.
The above calculation will give you the Gross Profit Margin, which indicates the financial and profitability condition of the business.
In very simple words, the gross profit margin will tell you how much profit you are making out of your business?
Similarly, you can also calculate the different ratios and margins like Net Profit, Operating Profit, etc to study the financial condition of your business.
But these indicators will provide correct results only if you have calculated the correct cost. Yes, a different person will calculate cost differently and thereby will get different results for the same indicator.
Next, your answer will also get changed, with different calculation for the cost.
If a company received $10,000 from selling products and incurred cost of $1000 for using the various resources then the gross profit would be $9000 (10000-1000).
Now, suppose at the same time, the company has incurred an additional cost of $1,00,000 for purchasing the land. What will be your gross profit margin in this case?
Will you also subtract the $ 1,00,000 from your revenue. In this case, your gross profit margin will get negative. In fact, it will become very difficult to recover this cost from your sales revenue.
So, What will you do in this case?
Simple, you will ignore this cost at the time of calculation. This is because this is a fixed cost and it is not a part of the Cost of Goods Sold. ( as discussed earlier in the article, the only cost of goods sold is get deducted from the sales revenue).
For more details, you can refer to this article at TechShristi: The Ratio Analysis For Your Business
Hence, it is very important to understand the different types of cost involved in running the business. Hereby in this article, I will share the top 6 different types of costs involved in running the business.
So, What are we waiting for? Are we ready?
The first name in the list is ‘Fixed Cost’. Fixed Cost, as the name suggests is the cost which remains fixed irrespective of a number of goods produced and sold. For example, Rent Paid for Using the Factory Premises, etc.
Always remember, the fixed cost has nothing to do with your business. This will be incurred automatically at a particular period of time irrespective of running the business.
Do you really think? It will be a wise decision to include fixed cost while calculating the profit per product sold.
Of course, Not. If fixed cost has no relation with your sold product then it should not be considered while calculating the profit.
The second name in the list is ‘Variable Cost’. As the name suggests, the variable cost is a cost which remains variable in nature. For example, Packaging Cost, Labour cost, Commission Cost, etc.
In simple words, the variable cost keeps on changing with every increase or decrease in the number of product produced and sold.
This cost is always calculated at per unit level. For example, the variable cost per unit is $1. It means you will incur $1 on every one unit production of the given product.
Yes, this cost will incur only if you run your business.
The next cost on the list is ‘Semi-Variable Cost’.It is also called as Semi-Fixed or Semi-Variable cost. As the name suggests this is a cost which remains fixed for a particular period and then gets converted into variable one. For example, Electricity Cost.
The electricity cost will remain fixed up to a particular limit and then on every additional consumption, you will be charged at per unit rate decided for it.
Next, the respective treatment will be given to fixed and variable cost involved in it. It means the fixed and variable cost will be treated separately in this case.
Marginal Cost is a cost incurred for producing one additional unit of a product or service. In simple words, it is an increase and decrease in the total cost of producing one additional unit of product or service.
Marginal Cost plays an important role in resource allocation. For example, assuming the current setup, it will tell you how much cost you will incur to produced one additional unit of product or service?
Next, you will compare this cost with your offers and thereby take the decision.
Break Even Cost
The last name on the list is ‘Break Even Cost’. Break Even Cost is simply a cost incurred to reach at no profit no loss point.
In simple words, it is a point where the total cost is equal to total revenue generated out of business.
The benefits of Break Even Costs are
- It helps you to determine the number of units that need to be sold in order to cover the cost or make a profit.
- It helps you to protect your business from being getting shut down. If any business is making less than break-even point then it means it is running at loss and hence very soon it will get closed down permanently.
Being an entrepreneur it is very important that you known the meaning of the term ‘Cost’. A proper understanding of different kinds of costs invovled is very important to measure the financial health of your business.
Trust me. a wrong cost calculation may cost your business to get closed permanently.
At last, please do not forget to share your feedback in below comment box. Next, if you face any problem in understanding the above concepts then feel free to contact us. We will be happy to help you.