LESSON 28: How to predict your costs – the heart of you Articles

LESSON 28: How to predict your costs – the heart of your plan

 While sales are the foundation of your plan, your ability to predict costs is the heart of your plan. Clearly this is so, because ‘sales minus costs equals profit’. And it is the elements of profit that are the major determinants of cash generation and behaviour. The ability to predict how costs will change when […]

28.1 To make your plan dynamic and easy to revise, build it so it automatically adjusts to changes in activity

 Previously we described how settling on a plan was likely to involve a deal of trial and error, of bargaining with yourself and evaluating your payback in return for the effort and so on you feel comfortable committing to. It is highly unlikely that you will hit the optimum result first time. Having entered figures […]

28.2 Types of costs and how they behave

 We will now take a close look at how costs behave. Once you understand that, you will be able to successfully mimic their behaviour in your planning model. The following table is a simple reminder of the various cost types and the way they can usefully be classified. Please remember that while this table and […]

28.3 Capital v Revenue revisited

 Let’s remind ourselves of the difference between capital expenditure and revenue expenditure. The way capital expenditure should be treated in your plan (and in your accounts) is quite different from the way revenue costs should be treated. Your planning model should have been constructed so that this distinction between capital and revenue is reflected within […]

28.4 Remember this vital distinction – fixed and variable costs – recap

 Fixed costs. Although fixed costs do change from time to time, they do not change often and most notably they do not automatically change in response to variations in activity. Fixed costs do not change one month just because you make a lot of sales that month. They are costs that do not vary closely […]

28.5 Many of your costs will increase or decrease in proportion to your sales

 In all but exceptional circumstances it is your sales that are the ultimate driver from which your costs follow because your sales are a measure of your business activity. There are cases where this may not be true – for example if you were investing heavily in research and development you would be incurring significant […]

28.6 Some of your costs will vary, but that variation will not be in proportion to sales

 For some costs, although they do change, that change has no close link to changes in sales. When building your model it makes sense to link them to something other than sales, or not to link them to anything at all. You could simply enter these costs straight into your model as monetary amounts, rather […]

28.7 Sales and marketing costs warrant special consideration

 One cost that needs special consideration is your sales and marketing. Because sales and marketing is so vital to your business success and to your ability to grow and control your business, you should have a tried and tested sales and marketing mechanism. If you do, you will be able to link your sales and […]

28.8 Now you can assign all your costs to one of these three groups

 Having thought about your costs and how they behave, you will be able to assign each to one of the following three main groups. Fixed costs, of all kinds Fixed costs can be entered into your model manually as monetary amounts. If you then make significant changes to your expected (planned) sales volumes, ensure you […]