Handling your costs

Costs are dangerous, costs are continuous. They're something you really have to see coming, like traffic when you're trying to cross a road.

Costs can have much the same effect as traffic, too, if they hit you.

In the previous episodes, we've talked about costs without being too specific. Now we have to get down to cases, and this is how you being your own boss is a very good thing.

Do it right, and from the start, you'll have control.

Every business starts with what are called Establishment Costs.

Establishment costs are normally:

  1. Leases, plant and equipment, trading stock, etc., your initial outlay.
  2. Cash assets, your starting cash.

Depending on your type of business, costs come in two basic types: Let's call them Predictable and Unpredictable.

They're usually called Fixed and Variable costs, but as you will see, they really do deserve another description.

Predictable costs include:

  • Costs like shop rental, power, phone, rates, anything which is periodic and regular. They're also considered to be overheads.
  • Contract costs, anything where you're working on known values. You don't have to guess what you're spending.
  • Employee wages and benefits.
  • Business administration costs, things like outside accountancy, tax returns, if you're paying someone outside the business on a regular basis.
  • Insurance. Every business needs some form of insurance, to protect against liabilities. Public liability insurance is one of the more obvious.
  • Taxes. They have to be factored into every transaction, either as tax payable, or tax deductible. Everything you make or spend has a tax element built in, and there's no prizes for getting it wrong.

Unpredictable costs include:

  • Repairs and maintenance.
  • Unusual, non-recurrent expenses like special promotions, renovations, purchases, legal fees, etc.
  • Unforeseen outlays. A bit of minor damage to your van can wipe out a week's profit, easily.
  • Debts where the amount owing can vary greatly. (You've heard of a balanced account. These things tend to be very unbalanced accounts, and they can affect your bottom line, drastically.)

Obviously, this is a highly simplified version of basic costs. Every business is different, every business incurs different costs.

You'll also be purchasing stock, buying and selling, and hopefully making a profit, and getting more business.

The bottom line is the common element for all businesses.

(Even the expression bottom line actually comes from the bottom of a Cash Payments Book, where the various totals for the business are made.)

Example:

Our IT guy from previous episodes had a good month last month, despite it being bill season.

Profit: He made ,000 for the month.

Tax: If this is an average month, which it now is, for him, he's making ,000 a year. His tax liability is about for the month, in his tax bracket. That's 45%, but he can claim some of them as his expenses.

Cash outlays: These are all things he has to pay upfront this month:

Insurance: Because he's a consultant, he has to pay Professional Indemnity insurance, and that's not cheap. It's a month, because he's doing high value contracts, and has had to take out million insurance.

Health insurance: Being self employed, he has to cover this himself. a month.

Electricity:

Phone:

Internet: (separate provider)

Out of pocket expenses: .

Mortgage:

Food:

Petrol: So low he didn't even bother to cost it, because all his business is local. He can walk to half of his clients and do the shopping while he's at it.

So for the month his outlay, cash, had to be . He still has the remaining , but of that, is payable in tax, before deductions.

A few things to think about:

He had to make that for the month. Those are unavoidable expenses, he can't get out of paying them.

Now-

  • What if he'd only made for the month?
  • What if he's only getting occasional work, or has to wait to get paid for past work?
  • What if he had other bills?
  • What if he was sick, and couldn't work?
  • What if some other big, uninsured, cost had suddenly come up, he was low on cash, and had to be paid on the spot?

The answer to the question is that unless there's a very healthy margin of profit above costs, and some sort of defense against unforeseen expenses, he'd be in real trouble, either this month, or next.

That would be taxable, too. Only about would actually be his, and the rest would be tax payable. He could have paid the bills, had a little cash left over, but the tax liability would be waiting for him.

He'd be slightly above breaking even, but not enough to get clear of his costs and actually make some capital. Money would be coming in the front door and going straight out the back door.

People usually borrow money to get out of trouble like this, but in business, like a credit card, you can borrow your way into trouble, too.

Businesses with bad credit ratings tend to be out of business. Their owners carry the credit history with them. Bankruptcy isn't fun.

So being your own boss means knowing the risks. Risk Management isn't just an expression. It means, literally, dealing with risks. In business, costs are all risks.

The risk is that you might not be able to cover them.

Businesses can die slowly, and expensively, if costs aren't under control. The scenario of just barely keeping up with costs is one of the most dangerous. Just to make it even more infuriating, you're working largely to pay costs, not to make money. That really doesn't help, when you're working flat out just to stay solvent.

You can stay in business, just barely, hoping to do better, and find yourself sinking further into debt. Sooner or later, things have to be paid.

Under those conditions you really have to question whether it's worth it. Sometimes bailing out is the better option. Pay the bills, get out of the way of the oncoming traffic, and move on.

You don't have to get into that situation, though. If you can pin down your costs, cover them, and make money, you're doing most of what needs doing to operate a successful business.

COSTS, BASICS:

You must have those costs covered, completely.

Costs are killers.

Never allow your costs to get out of control.

Don't leave anything unpaid, because you'll find it weighing you down later... if there's a later to worry about.

The IT guy is his own boss. He knew well ahead what his costs would be. He's highly experienced, and he did know how to organize them. He's making a lot more, gross, than his costs, even in a quarter full of bills. As you can see, they're just about all regular costs. He's made sure he knows what he's going to be paying, in advance.

The out of pocket expenses were for the second car, which were unavoidable, and he can't claim on them, because they're not business related. But he's not taking much damage, because of his sales volume.

As you can see from the figures:

  • He's not borrowing, and letting himself in for interest liabilities, because he doesn't need the money.
  • He doesn't have many overheads, because he's avoided them, deliberately.
  • He's working from home, not spending on an office, not buying expensive equipment and taking related costs like servicing.
  • What he's paying for are things he needs. There are no unnecessary costs.
  • What he's also done is cut out any business expenses which would qualify as too risky. He's protecting his profits, making sure his business is viable.
  • He never buys anything where costs are unspecified. He avoids the credit card effect, entirely.

He also knows what he's going to be doing:

  • Next month, he'll be paying his accountant to make sure his records are properly kept so he can claim on his expenses for his tax return.
  • Next year, he'll start looking at taking on a couple of part time employees, because his business is expanding.
  • He costs everything, and goes looking for the best deals he can get.
  • If something's too expensive, he just won't do it. He's quite rightly not prepared to risk a good cashflow for no good reason. He will not spend at all, unless he can get a definite cost benefit.

The people doing business with him have by now noticed how he does business. Now, they only approach him with things they know are good deals that he would be prepared to look at. They know he expects good deals from them.

He's saving himself a lot of time, as well as money, not getting inflicted with people trying to sell him bad deals. He really has earned a very good reputation as a businessman. The people who can give him what he wants consider him a very good client to have, because he can always pay for what he does buy, so he often gets a discount.

You'll have noticed from this brief history of the IT guy's business that he's been working on some very strong, basic, trustworthy principles, right from the start, and they're why he's doing so well.

Cost management is the basis of his business methods.

Being his own boss has paid off in many ways for our IT guy, because he's been in a position to make the decisions that have made his business healthy and able to grow.

You're the boss, remember. You do know how to get around costs, like oncoming traffic, if you can see them coming.