Virtuoso Team Consulting, Inc.

What constitutes a cost for your business?

For such a simple question, there is a beast of an answer and it all starts with, “it depends.”

Different businesses, different monetary policies, different objectives and methods of accounting all play into the answer which makes it somewhat difficult to say. Additionally, there are two kinds of costs, fixed and variable, that further complicate matters.

A short definition of each type:

Fixed Costs (also known as sunk costs) can be thought of as costs that stay pretty close to the same regardless of how slow or busy your business is. Examples would include rent, salaries, and insurance.

Variable Costs change based on how much work is being done. Examples would be COGS (cost of goods sold), and payroll.

I will give two examples that demonstrate the range of views, the first was a prospective client, and the latter is my own method.

This example can be defined as the straight costs of goods. This was a widget manufacturing business operating as an unofficial partnership. When pricing an order of widgets, they knew how much the individual components cost, how many would give them an economy of scale, and believed that any amount over that would be “profit”. This is actually referred to as COGS, or Cost of Goods Sold, and is only one cost associated with the actual expense. In this case, the “profit” was needed to cover rent, utilities, expenses, upkeep on equipment, and what was left was considered payroll.

A simple solution to this would be to recognize their costs, make the necessary adjustments to their billing prices, and fix the problem. They felt that by raising their rates, clients would go to other vendors where they can get widgets for less. Note: When competing on price, you can only be as smart as your dumbest competitor.

I count every expense I have, first personally, then for the business. My personal expenses are my payroll expense for the business. For the business, I again count every expense I can foresee, including new equipment I will want in the future. By using this method, I have retained earnings (left over money or profit) so when I need a new computer or printer, I do not have to go into debt for it. While this method is more time consuming to setup initially, it is a far better system, in my opinion. I know all of my bills will be paid, and anything left over is actually profit I can reinvest in the business.

So I bring to your attention this, the U.S. Postal Service is posting a $2.4 Billion loss in 2009Q3 (third quarter). What are they doing wrong? If this were your company, what methods would you use to solve the problem? Yes, this is really the stuff I think about in my down time…

This entry was posted on Wednesday, July 29th, 2009 at 11:35 AM and is filed under Consulting, Management. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.