Business Administration - Basic Skills Guide (SKAT, 1994, 162 p.)

Business Administration - Basic Skills Guide (SKAT, 1994, 162 p.) Module 4: Costing and Pricing Introduction Goal Purpose Types of Costs Definition Material Costs Labour Costs Depreciation (introduction...) Calculation Inflation Format Summary Format Credit Costs Other Costs Costing Purpose Variable Costs Fixed Costs Calculating the Production Costs Format Variable Costs Fixed Costs Total Costs Pricing Purpose Pricing Factors (introduction...) Costs Market Price - Quantity Reducing Costs Conclusion Appendix A: Exercise in Costing 1. Depreciation Calculation 2. Costs Calculation

Business Administration - Basic Skills Guide (SKAT, 1994, 162 p.)

Module 4: Costing and Pricing

Introduction

Goal

This module explains, what costs are and how to calculate them. In addition, some hints are given on how to find the best selling price for your products.

Purpose

The main purpose of business is to make money, but it is not always easy to know whether you are making or losing money. If you spend more money producing goods than you get from selling them, you will lose money.

To avoid getting into this situation, it is important to know the production costs per piece. Only if you set a selling price that allows you at least to cover all your production costs, you will make a profit.

Types of Costs

Definition

Costs are all expenses which result from producing and selling goods. The main types of costs that you should know are described below.

Material Costs

To produce any goods you need the following types of material:

· Raw materials. These are the basic materials which are combined to make your goods. Examples are cement, sand, aggregate, colorants and wire to produce MCR-tiles.

· Consumables. Consumables are the materials that are used up - consumed - in the process of producing and selling goods. However, consumables do not make part of the final product. Examples are plastic sheets to produce MCR-tiles.

Labour Costs

You have to pay the employees of your business:

· Wages. These are payments made to the workers who are directly involved in producing goods. Wages are usually based on time or on volume of production.

· Salaries. Payments to staff who are not directly involved in the production process. These include foremen, administrators, salesmen and drivers. Normally salaries are based on time worked and are not related to the amount of goods produced.

· Social security. In many countries employers have to make social insurance payments for every worker. Social security can include payments into a pension plan and payments during illness or maternity leave.

· Holidays. In some countries workers are paid for a few weeks of holiday.

Depreciation

Depreciation is the special term used when referring to the costs to the business that results from investments losing their value over time.

Investments are all the items owned by the business that last a long time. Investments include production equipment such as machines, administrative equipment such as office furniture, storage cabinets, calculators, and land and buildings which belong to the business. With the exception of land, all investments lose their value over time. For example, an old building is worth much less than a new one.

Figure

This loss in value are costs. Therefore, depreciation must be included when calculating production costs.

Calculation

The yearly amount of depreciation is determined as follows:

Step 1

Estimate how many years an investment will last. This number of years is known as the lifetime.

Step 2

Divide the costs of the investment by the lifetime in years to get the yearly amount of depreciation.

If a profit and loss statement (see Module 5) is made every month, the monthly depreciation must be calculated. A year has twelve months; therefore the monthly depreciation is one twelfth of the yearly depreciation. If the yearly depreciation is LU 600, the monthly depreciation is 600 divided by 12 = LU 50.

Inflation

If the rate of inflation is high, e.g., 100% per year, the LU 600.- do not reflect the actual loss in value after one year, because now the LU 600.- are only worth half. The higher the rate of inflation, the stronger is this effect. Therefore, in countries with a rate of inflation higher than 30%, the calculation of depreciation should be based on a hard currency such as US dollars.

The monthly depreciation is calculated in the same way. First calculate the monthly depreciation in dollars, then calculate the monthly depreciation in local currency.

Format

With the format shown below the yearly depreciation can be determined, even in a country with a high rate of inflation. In the upper part, the yearly depreciation amount is determined as shown above. In the lower part, the amounts of yearly depreciation in the local currency are determined.

The effect of a growing rate of inflation can be seen very well: The amount of depreciation in local currency is increasing all the time.

Figure

Summary Format

In the profit and loss statement (see module 5) the total amount of depreciation is needed. To determine this figure you may need the format “Depreciation Summary”.

Credit Costs

Most businesses need credit from time to time. Money borrowed from a bank or moneylender is not free. Interest charges and bank fees normally must be paid when a business borrows money.

Other Costs

There are many other types of costs such as

· Water and energy, including electricity, firewood, and fuel costs,
· Transports, including shipping costs,
· Maintenance, including repairs to buildings and equipment,
· Office expenses, including stationery, postage and telephone,
· Marketing, including advertising and selling costs,
· Taxes and fees,
· Education of your workers.

Costing

Purpose

The purpose of costing is to find the best selling price for your products. The costs of producing goods must be calculated before the selling price can be determined.

You must know which costs change as the quantity of goods produced changes and which costs remain the same even when the production volume increases or decreases. Thus, there are two major categories of costs: ‘variable costs’ and ‘fixed costs’.

Variable Costs

Variable costs are costs that are directly related to the volume of production. If the volume changes, variable costs will change proportionally. The following costs are variable costs:

· Raw materials,
· Wages and social security payments for production workers,
· Energy,
· Water,
· Transports.

Fixed Costs

Fixed costs are those costs that do not change - that is, they remain fixed - even when the volume of production increases or decreases. The following costs are fixed costs:

· Consumables,
· Salaries and social security payments for employees not directly involved in producing tiles,
· Depreciation,
· Interest charges and bank fees,
· Repairs and maintenance,
· Office and administrative expenses,
· Marketing expenses,
· Taxes and fees,
· Education.

Calculating the Production Costs

Format

The costs per piece are the total of all variable and fixed costs divided by the number of pieces produced. The following is an example of a cost calculation for FCR/MCR tiles:

Figure

Variable Costs

We need to know the costs per piece. Sometimes, it would however be rather difficult to calculate these costs per piece. For that reason, it may be advisable to base the calculation on a certain number of pieces.

Step 1

Determine the total costs of the raw materials needed to produce a lot of goods. Please keep in mind: The same dimension of lot, for example 1’000 tiles, must be used for all variable cost calculations.

Step 2

Determine the total labour costs needed to produce the same lot of goods.

Step 3

Add the raw materials costs and the labour costs together to get the total variable costs of producing one lot of goods.

Principally, the expenses for water, energy and transports would make part of the variable costs. However, these costs are small and it would be difficult to determine them even for a whole lot of goods.

For that reason in this example the costs for water, energy and transports are considered to be fixed costs.

Step 4

Divide the total variable costs of producing a whole lot by the number of pieces in a lot to get the total variable costs per piece.

Fixed Costs

Total fixed costs do not depend on the quantity of goods produced. However, the fixed costs per piece do vary with the number of pieces produced. If you only produce and sell one piece per year, all the fixed costs have to be covered by this one piece and the fixed costs per piece would be very high. However, if you produce a great many pieces per year the fixed costs per piece are much smaller.

As this example clearly demonstrates, the selling price would have to be much higher if production is low - because at low levels of production the fixed costs per piece are high. This leads to the following conclusion:

The fixed costs per piece are calculated as follows:

Step 5

The time period and the number of pieces produced during the specified time period must be determined.

Step 6

Determine the total fixed costs. A common method of determining costs is to base them on the costs of previous years with some increase added to account for inflation and changes in sales volume.

Step 7

Divide the total fixed costs by the number of pieces to be produced to get the fixed costs per piece.

Total Costs

The total costs per piece are the sum of the variable costs per piece and the fixed costs per piece.

Step 8

Add together the fixed costs per piece and the variable costs per piece.

In Appendix A, you will find a calculation exercise. You can use it for your practice.

Pricing

Purpose

It is very important that the selling price of your goods is correct. If the selling price is too high, nobody will buy your products, because people will buy from cheaper competitors. If the price is too low, you will make a loss, because you will not cover your production costs. The various factors which influence the price must be taken into consideration and then a price must be fixed which optimally fits the situation.

Pricing Factors

The price of a product is mainly determined by its cost and by the market situation:

Costs

The costs of production are the best basis for determining the selling price. The selling price should always be higher than the costs; the difference between costs and selling price is known as profit.

Figure

The higher the selling price, the higher the profit and the greater your gain.

Market

If, however, the selling price of your goods is too high, your customers will buy from your competitors. Or they may use other products. They will for example use rooting materials such as iron sheets or clay tiles.

Price - Quantity

The demand for goods might vary strongly with the price. Because of this, it is possible for a small price reduction to lead to a big increase in sales. It is often better to sell many pieces at a low price rather than to sell a few pieces at a high price. A cost calculation will quickly show which alternative is best.

In the ‘Financial Analysis’ section you will learn how to calculate the ‘breakeven point’. The ‘breakeven point’ is the exact level of production, at a given price, where you make no profit and no loss - that is the point at which the costs of production and the selling price are ‘even’.

Reducing Costs

When production costs are higher than the selling price, you have the following possibilities:

· Reduce costs. Can you find a supplier of raw materials who will give you a better price? Can you employ less workers or increase the productivity of your existing workers?

· Make different or additional products with a better cost - price relation. Can you for example change your tiles so that they are a special colour, unique shape or a different form? Do they have a better cost - price relation?

· Produce more. Can you produce and sell more goods and benefit from the lower fixed costs per piece?

Conclusion

Please never forget the following rule:

Figure

Appendix A: Exercise in Costing

1. Depreciation Calculation

In January 1988, Mr. Garcia bought a new vibration table for LU 3’000. The lifetime of the table is estimated to be 5 years. The inflation is about 50% per year. For that reason, Mr. Garcia decides to calculate the depreciation in US$. The exchange rates to the US$ were the following:

Please determine the depreciation amount in local currency for the 31^st of December of the years 1988, 1989, 1990, 1991 and 1992. On the next page, you find the answer.

Figure

2. Costs Calculation

Calculate the production costs per tile, based on the following figures:

· All costs are given in LU (Local Units of currency). Variable costs calculations are based on the costs of producing 1’000 tiles. All figures are based on the period from the 1^st of January to the 31^st of December 1992.

· 20 bags of cement and 1 m³ of sand are needed to produce 1’000 tiles. One bag of cement costs LU 300. One m³ of sand costs LU 280.

· There are three workers and one foreman. They produce 1000 tiles in one week (40 working hours). The workers are paid LU 30 per hour. The foreman is paid LU 40. Social security costs, paid by the business, are an additional 10% of the wages.

· All fixed costs are based on estimates for one year. Mr. Garcia expects to produce 50’000 tiles per year.

· Mr. Garcia estimates that his yearly fixed costs will be:

· Water and energy: LU 1’000,

· Transports: LU 2’000,

· Mr. Garcia will pay himself a monthly salary of LU 5’000. In addition there will be social security costs of 10% of his salary,

· Mr. Garcia’s records give the following information needed to calculate depreciation:

- The buildings cost LU 150’000. They will last for ten years,
- Equipment costs LU 300’000. It will last for five years,

· Mr. Garcia has a bank loan of LU 100’000. The yearly interest rate is 18%,

· Maintenance: LU 20’000,

· Office expenses: LU 2’000,

· Marketing: LU 40’000,

· Fees: LU 16’000,

· Other fixed costs: LU 10’000.

The following page has a few hints to help you find the answer.

Hints

· Wages, salary and social security expenses

The social security expenses should be added to the hourly wage of the workers and the foreman.

The social security expenses should be added to the monthly salary of Mr. Garcia.

A monthly salary must be multiplied by 12 to get the yearly salary (because there are 12 months in a year).

· Depreciation

To determine the yearly depreciation, divide the costs of each investment by its lifetime.

To determine the total yearly depreciation for all investment items add together the yearly depreciation for each investment item.

· Financial Costs

The financial costs are the yearly loan interest.

Figure

Business Administration - Basic Skills Guide (SKAT, 1994, 162 p.) Module 5: Profit and Loss Statement Profit and Loss Statement Goal Purpose Concept (introduction...) Goods Sold Expenses Basic Formula An Example of a Profit and Loss Statement Introduction Value of Stock Depreciation Cash book Calculation Appendix A: Exercise in Profit and Loss Statement (introduction...) 1. Value of Stock 2. Depreciation of Equipment and Workshop 3. Cash Transactions 4. Profit and Loss Statement 5. Answers to the Exercises a. Stock Record b. Depreciation c. Cash Book d. Profit and Loss Statement Appendix B: The Difference between Cash and Profit 1. The Question 2. Where the Difference Comes From 3. Example

Business Administration - Basic Skills Guide (SKAT, 1994, 162 p.)

Module 5: Profit and Loss Statement

Profit and Loss Statement

Goal

This module explains, what a profit and loss statement is used for and how it is made.

Purpose

As long as there is some cash, a business will live. But after a certain time of loss, the business will cease to exist, because all the money will be used up. Please keep in mind:

Therefore, it is not enough to control the cash of your business, you need to know, whether your business is making a profit or not.

The cash book tells you, how much cash you have in your cash box. The profit and loss statement is used to determine how much profit (or loss) your business has made. If you have a cash book and a profit and loss statement you can clearly see how much of your cash really is profit (see Appendix B for further information).

Concept

The following formula shows the basic structure and components of the profit and loss statement:

There are three different types of profit: gross profit, net profit, and retained profit. For the business person net profit is important because it shows how much can be withdrawn from the business. For the business the retained profit is important because it shows how much of the profit is available to expand the business after the owner or partners have withdrawn their share.

Goods Sold

The costs of goods sold means the total cost of all materials which make part of the products sold during a given period. Therefore costs of goods sold might be costs of all raw materials.

If you only do one profit and loss statement per year and do not need exact figures, this definition will do. Normally, however, the profit and loss statement is done every one to three months. Within this period the amount of raw materials bought does not correspond exactly to the amount of raw materials used. For example, the cement bought in one month may be sufficient for the following three months. The costs of goods sold would be high in one month and low in the next months, even though the same amount of raw materials was used every month. This effect distorts the result of the profit and loss statement. For that reason, changes in stock should be taken into account:

If the stocks of raw materials are reduced in one period, this is considered to be costs.

The following formula shows how to calculate a more accurate costs of goods sold:

Expenses

All the other costs of production are called expenses. They include:

· Wages and salaries,
· Social security expenses,
· Water and energy,
· Transports,
· Marketing,
· Maintenance,
· Rent,
· Depreciation,
· Taxes and fees,
· Interest on loans.

Basic Formula

The basic formula needed to calculate profit and loss is:

An Example of a Profit and Loss Statement

Introduction

A profit and loss statement should be prepared monthly, quarterly or annually. The information shown in the profit and loss statement is obtained from three sources:

· The Stock Record format gives the data for initial and final value of stock.
· The depreciation figures are found in the Depreciation Summary.
· All the other figures are found in the Cash Book.

These three sources are illustrated below.

Value of Stock

The value of stock is taken from the stock record.

Figure

The following points are important:

· The value of stock has to be determined at the beginning and at the end of each accounting period. Normally, the beginning of one period is the same as the end of the previous period.

· Make sure that the value is based on the actual costs for raw materials as well as for final products. To determine the “costs/unit” of the raw materials, consult the invoices of the most recent deliveries. The costs per piece of final product has to be calculated as shown in Module 4, “Costing and Pricing”.

Depreciation

The method for calculating the depreciation of buildings and equipment is described in the Module 4, “Costing and Pricing”. The amount shown in the profit and loss statement is based on the total in the “Depreciation Summary”:

Figure

Cash book

The cash book is already known from Module 3, “Cash Management”:

Figure

Calculation

The profit and loss statement is now made as follows (for an example see next page):

Step 1

Decide on the time period, for which you need to make the profit and loss statement. If there is no inflation and your business is doing well, once per year is enough. If you have a lot of changes in quantities, costs and prices or if you frequently have a lack of cash, then the profit and loss statement should be prepared monthly or quarterly.

Step 2

Determine the value of stock at the beginning and at the end of the period. Fill in the figures in the profit and loss statement.

Step 3

The “Depreciation Summary” may help to determine the depreciation. Determine the depreciation for the time period and, if necessary, calculate it in LU. Then fill the figure in the profit and loss statement.

Step 4

Now take the cash book. Within the calculation period of the statement, all cash transactions with a certain code are added up and the result is entered into the corresponding field of the statement. This is done with all the codes of the statement.

The corresponding profit and loss statement looks now as follows:

Figure

How to analyse the result of the profit and loss statement is explained in the next module (module 6: “Financial Analysis”).

Appendix A is an exercise for your practice.

Appendix A: Exercise in Profit and Loss Statement

Mr. Garcia decides on preparing a profit and loss statement for the first quarter of 1992. For that reason he is looking for the figures needed to do so:

1. Value of Stock

On the 1^st of January Mr. Garcia counts his stocks. He has the following raw materials:

· 20 bags of cement,
· 10 m³ of sand,
· 50 kg of colorants,
· 20 m of wire,
· 1’000 tiles.

Next, Mr. Garcia checks his records to find out how much he paid for each item:

· He paid LU 80’000 for 200 bags of cement,
· He paid LU 6’000 for 12 m³ of sand,
· Each kg of colorant costs LU 100,
· 100 m of wire cost LU 5’000.

Using this information Mr. Garcia determines that it cost LU 18’000 to produce 1’000 tiles.

What is the value of Mr. Garcia’s stock on the 1st of January? To find the answer to this question, make a copy of the Stock Record Format, and use the figures given above. Below, you will find the answer.

Now, make a copy of the Profit and Loss Statement Format and enter the figure in the field “Initial Value of Stock”.

Mr. Garcia also determines the stock on the 31^st of March and finds that it is LU 20’000. Please enter this figure in the field “Final Value of Stock” in the profit and loss statement.

2. Depreciation of Equipment and Workshop

What is the yearly and quarterly depreciation, when the exchange rate is 100? Please enter the figure for the quarterly depreciation into the profit and loss statement in the field “Depreciation”.

3. Cash Transactions

Please prepare a cash book for Garcia’s Tile Factory. Enter the following cash transactions in the cash book and determine the transaction codes used for the profit and loss statement.

Remember: Investments and repay of loans are not expenses and, therefore, do not make part of the profit and loss statement.

· On the 1^st of January there are LU 60’000 in the cash box.

· On the 5^th of January Mr. Garcia buys plastic sheets for LU 5’000. The voucher number is 101.

· On the 10^th of January Mr. Brown pays last year’s invoice. The amount is LU 100’000 and the invoice number is 356.

· On the 15^th of January 200 bags of cement are delivered. Mr. Garcia pays LU 75’000. The invoice number is 102.

· On the 25^th of January Mr. Garcia pays his workers: LU 30’000. The voucher number is 103.

· On the 3^rd of February, Mr. Garcia buys office material for LU 2’000. The voucher number is 104.

· On the 7^th of February, Mr. Garcia starts an advertising action in the newspaper “Daily Mail” and pays LU 18’000. The invoice number is 105.

· On the 12^th of February, Mr. de Rivero fetches his tiles and pays LU 150’000. The invoice number is 106.

· On the 18^th of February, Mr. Garcia pays LU 5’000 for transport. The invoice number is 107.

· On the 21^st of February, new moulds are delivered. Mr. Garcia pays LU 70’000. The invoice number is 108.

· On the 25^th of February, Mr. Garcia pays his workers: LU 30’000. The voucher number is 109.

· On the 28^th of February, Mr. Domingues pays LU 100’000 for tiles he received. The invoice number is 110.

· On the 8^th of March, 20m³ of sand are delivered. They cost LU 5’000. The invoice number is 111.

· On the 11^th of March, Mr. Garcia pays for the repair of his vibrating table LU 10’000. The invoice number is 112.

· On the 17^th of March, Mr. Garcia has to pay the water fee of LU 10’000. The invoice number is 113.

· On the 25^th of March, Mr. Garcia pays his workers: LU 30’000. The voucher number is 114.

· On the 30^th of March, the interest for the first quarter has to be paid: LU 15’000. The invoice number is 115.

· On the 31^st of March, Mr. Garcia decides to draw LU 20’000. The voucher number is 116.

4. Profit and Loss Statement

Please prepare now the profit and loss statement for Garcia’s Tile Factory for the period from the 1st January to the 31st of March.

All the information you need to prepare the profit and loss statement is given above.

5. Answers to the Exercises

a. Stock Record

Figure

b. Depreciation

The total yearly depreciation is $ 600. The quarterly depreciation is one forth of that:

With an exchange rate of 100, the quarterly depreciation is 150 × 100 = LU 15’000. This figure is entered into the profit and loss statement.

c. Cash Book

Figure

d. Profit and Loss Statement

Figure

Appendix B: The Difference between Cash and Profit

1. The Question

In appendix A you find an exercise, where you make a profit and loss statement from a stock record, the depreciation summary and the cash book. There you find the following figures:

· The Retained Profit from the 1st January to 31st March is LU 63’000
· The Cash on Hand in the Cash Box on 31st March is LU 85’000

Question: Where does this difference come from?

2. Where the Difference Comes From

The difference between cash and profit can be explained by the following:

· Investments (“new moulds”) reduce the cash, but they are not expenses. Investments are irregular and large cash transactions. If they were included in the expenses, the result of the profit and loss statement would be distorted.

· Depreciation is an expense but it does not reduce cash.

· Loan Repayments reduce cash, but they are not expenses. Loan repayments are irregular and large cash transactions. If they were included in the expenses, the result of the profit and loss statement would be distorted. However, the costs of loans are taken into consideration. The loan interest is an expense (and also reduces cash).

· Changes in the value of stock change the profit but do not change cash.

3. Example

In the case of Garcia’s tile factory, the difference between cash and profit can be explained by the following calculations:

Business Administration - Basic Skills Guide (SKAT, 1994, 162 p.) Module 6: Financial Analysis Introduction Goal Purpose Profit and Loss Statement Purpose Why Profit? What is profit? Analysis Improve Profit Break-Even Point Purpose Definition Calculation Capacity Price Extra Costs Example Format Exercise

Business Administration - Basic Skills Guide (SKAT, 1994, 162 p.)

Module 6: Financial Analysis

Introduction

Goal

This module explains, how to analyse and interpret the figures from the profit and loss statement and how to determine and analyse the breakeven point.

Purpose

Good decisions are necessary to manage a business successfully. Good decisions are based on the analysis of information about the business itself, the local and national economy, and the market potential for your products. Your books and records provide part of the information about the state of the business, namely, basic financial information. This section tells you how to analyse and interpret financial information about your business.

Profit and Loss Statement

Purpose

Module 5, “Profit and Loss Statement”, explained how to calculate profit. But why should you make a profit? And what information can you draw from a profit and loss statement?

After you have analysed the profit and loss statement, you should be able to identify and understand your financial problems.

Why Profit?

Even if a business makes a loss every year, it may still live as long as there is cash. But only for a certain time, because all money initially invested for workshop and equipment will be used up and there will be no money left to replace old equipment or to expand the workshop. After a certain time of loss, the business will even cease to exist, namely then, when all the money is used up. But there are also other reasons for making a profit.

· Loan repayments,
· Unexpected costs and emergencies,
· Cash reserve for when business is slack,
· Business expansion,
· Income for you and your family.

What is profit?

Generally speaking, profit is the difference between income (= gross profit) and costs (= expenses).

Figure

The higher the income is, compared to the costs, the higher the profit. Normally, income and costs are not stable, they change all the time. If, for example, the income increases and the costs stay stable, the profit will increase. If, on the other hand, the income stays stable and the costs increase, the profit becomes smaller or even turns to a loss.

Analysis

The Analysis is made in three steps:

Step 1

What trend has profit/loss?

Make an actual profit and loss statement. Is there a profit or a loss? Is it higher or lower compared to earlier profits/losses? Is there a trend over the last periods? If there is an increasing loss, you are in a very bad situation. If there is a loss, but losses becoming smaller every period, you still are in a bad, but improving situation. If there is a profit, but profits are becoming smaller every period, you should carefully analyse your situation. Only if there is an increasing or at least stable profit, you are in a good position.

Figure

Step 2

What trend has sales income?

Use the last three to five profit and loss statements and compare the figures for sales income. What general trends do you see? Are sales increasing or decreasing? What types of good had increasing or decreasing sales? Did customer preferences change? Were your prices too high? Was a certain type of good of poor quality?

Figure

Step 3

What trends have costs?

Use the last three to five profit and loss statements and compare the figures for costs. What general trends do you see? Are costs increasing or decreasing? Which prices and costs are increasing faster than others? Was there a loss or waste of raw materials? Did you need more raw material because of poor quality?

Figure

Improve Profit

If there is a loss or a decreasing profit, the question arises, how the profit could be improved.

Step 4

How do you improve the situation?

There are four basic ways to improve the situation:

1. Decrease costs

Costs should be as low as possible. You should use every chance to cut your costs. In Module 4, “Costing and Pricing”, you may find some ideas, how to do so.

2. Increase sales

When you increase your sales through a marketing effort, you must also increase your production. With higher production levels, fixed costs such as administration, management, marketing, depreciation and interest normally remain stable, resulting in a decrease in the fixed costs per piece and an increase in the profit per piece (see Module 4, “Costing and Pricing”).

3. Increase the price

If you increase your prices while your costs remain stable, your profits will increase. However, before increasing your prices, you must make sure that your prices remain competitive in the market and that you are still able to sell all the tiles you produce.

4. Change the product

Another product or changes in the actual product, such as new colours, unique shapes and original designs may make the product more attractive to customers and they may be willing to pay more for it. Moreover, there may be less competition for other or changed products. You may sell more products at a higher price.

It depends on the situation which strategy is the best. In some cases, even a combination of two or more strategies may be required.

Break-Even Point

Purpose

The profit not only depends on the price but also on the quantity of goods sold. If you are able to produce and sell much more goods than before, the profit may be higher even if you sell your goods at a much lower price. But what quantity of goods do you have to produce and to sell at a given price to be profitable? How is the relation between quantity, price and profit?

Definition

The key to understand the relation between quantity, price and profit are the fixed costs. They stay stable when you produce more goods, but the fixed costs per good will decrease.

At the break-even-point, the total income is the same as your total costs - you make neither a loss nor a profit. In other words, you ‘breakeven’.

If you sell more goods, you will make a profit. If you sell less goods, you will make a loss. Before you decide how many goods to produce it is always good to know the breakeven point at the current market price.

Calculation

The breakeven point is calculated as follows:

Step 1

Determine the variable costs per piece. The total variable costs for a specific period is divided by the amount of pieces sold in that period.

Step 2

Determine that part of the selling price which can be used to cover the fixed costs. This is the difference between the selling price (D) and variable costs per piece (B/C).

Step 3

Determine the number of pieces which have to be sold to reach the breakeven point. This is the total amount of fixed costs (A) divided through the part of the selling price which can be used to cover the fixed costs (D - (B/C)).

Capacity

It is important to know if it is possible to produce the amount of goods needed to reach the breakeven point. For this reason, the capacity utilization at breakeven point should be calculated. If the resulting utilization is about 90% or higher, then the capacity of the workshop is not enough. In such a case either the capacity would have to be increased - perhaps with additional equipment - or the breakeven point can be reduced by lowering costs or increasing the selling price. Keep in mind that all tiles produced have to be sold, and that the selling price cannot be higher than your customers are willing to pay. Capacity utilization at the breakeven point is the relationship between the capacity used at breakeven point and total productive capacity of the business.

Price

Sometimes it is important to know the lowest price at which a certain number of goods can be sold without making a loss. This is the break-even price. If you sell the goods at a higher price than the break-even price you will make a profit. If you sell them at a lower price, you will make a loss. Remember, the break-even price increases if the number of goods produced and sold decreases. To calculate the breakeven price divide the total costs (fixed + variable costs) by the number of goods sold. The result will be the breakeven price.

Extra Costs

Sometimes it is necessary to take extra costs into account, for example, the repayment of loans. In such a case, you would have to sell additional goods to make a profit. To calculate the breakeven point including loan repayment, calculate the fixed costs plus the repayment amount, then divide this amount by the part of the selling price, you can use to cover the fixed costs. The result of this calculation will be the number of goods you must produce and sell to reach break-even point including loan repayment.

Example Format

On the following page, you see an example how the calculation of break-even-point, capacity utilization, break-even-price and breakeven-point with loan repayment could look like. The figures needed for the calculations are taken from a profit and loss statement, the manufacturer’s equipment specifications, or are estimated based on actual experiences.

Example format to calculate the break-even-point

Exercise

Determine the figures for your own business and then calculate the breakeven point, the capacity utilization, the breakeven price and the breakeven point adjusted for loan repayment.

Business Administration - Basic Skills Guide (SKAT, 1994, 162 p.) Module 7: Marketing Introduction Goal Purpose The Product Definition Features Quality Price/Quantity Marketing Tools Purpose Distribution Promotion Selling (introduction...) Main Points Impression

Business Administration - Basic Skills Guide (SKAT, 1994, 162 p.)

Module 7: Marketing

Introduction

Goal

This module explains basically, what marketing is and gives some ideas how marketing can be done.

Purpose

The purpose of marketing is to find out who your customers are, what their needs are and how these needs can be fulfilled. Marketing is responsible for the design and distribution of products. Selling is necessary for a successful business and marketing is necessary to sell goods. Marketing is an essential part of running a business and should not be neglected.

The purpose of this module is to give you a little basic knowledge about marketing and show how this knowledge can be used to improve your business. The most important aspects of the product are described and the marketing tools “distribution”, “promotion” and “selling” are presented.

For more detailed information please consult the “Marketing and Selling Guide”.

The Product

Definition

Marketing is concerned with finding out what customers need. It is also responsible for the design of products. Tiles, for example, vary with regard to shape, size, colour, quality and price.

Features

You need to find out what your customers need, when they need it, and where they want it. There are many ways to find out what customers want. Below some possibilities are given how to do this:

· Ask existing and potential customers what they need. When you visit a customer, listen to him and try to find out what he really needs. You may have to offer new products to meet the needs of your customers.

· Analyse your sales: How many goods of each type were sold? Are there trends?

· Find out current trends in the market. Are there new products? What advantages and disadvantages do they have compared to your products?

· What are your competitors doing? Are they having more success? If so, what are the reasons for this?

· Analyse your own and your competitors’ products. What are the strong points and what are the weak points of your products compared to those of your competitors? Could you improve your position? And if so, how?

Quality

Most customers do not like products with poor quality. They will hardly buy the same product again, even if the quality has improved. High quality is one of your best marketing tools. Therefore, only offer products with a high quality.

Test every product before selling it, to see whether it meets your high quality standard.

Price/Quantity

As you have seen in module 4 “Costing and Pricing” and in module 6 “Financial Analysis”, price and quantiy are interdependent. If the demand for a certain product is high enough, it may be interesting to produce and sell more pieces at a lower price. However, the selling-price should always be higher than the production costs of that product.

Marketing Tools

Purpose

Even if your products meet customer needs, you cannot be sure that your customers will buy them. You have to inform potential customers about your products and their advantages. For this reason you have to think about distribution channels as well as promotion and selling.

Distribution

When starting your business, it may be quite difficult to inform people about your products and to sell enough goods to make a profit. It may be a good idea to sell to retailers who then sell at speciality shops (for example building materials shops). The price a retailer pays will be lower than the one a customer will pay. Your marketing costs, however, are lower and the greater turnover will help to cover fixed costs. In addition, because retailers normally pay cash on delivery, you will have less debtors.

Promotion

Even if you offer an attractive product at an attractive price, people will not buy your products if they do not know about them. For this reason, you should promote your products and other services. When planning a promotion campaign, the following points should be considered:

· You need to have a clear idea who should know about your product. Who decides whether your tiles will be bought and used?

· Next, you should find a way to make people aware of your product. How can potential customers learn about the advantages of your products?

· You have to think about the message: what would you like to tell people?

A few more ideas for promotion campaigns are given below:

· To make people aware of your products, you can demonstrate your products at fairs or at busy places where people can see them.

· You might rent a display window to show your products.

· You can place advertisements in newspapers, on the radio and television.

· It is also a good idea to make special conditions for customers who are important people. If they have trust in your product, other people will follow.

Selling

Even if potential customers know about your products, you still have to actively sell your products. Selling skills can be learned. You can learn more about selling in the special toolkit on marketing. In this module only a few essential points are mentioned:

Main Points

Normally, there will be other businesses selling the same products. You need to have good arguments and reasons why your products are better than those of your competitors. This means that you must know the strong points of your products. Unfortunately, most products also have weak points. It is important to know their disadvantages and to have good arguments to dispel your customers’ doubts.

However, do not tell your customers things which are not true.

Impression

An important point is the impression a potential customer has of you and your workshop during negotiations. If he has a positive impression, it is more likely that he will decide to buy your tiles.

* Including direct social security expenses