Yes I attended a kegger or two while I was going to college.
I seem to recall a few whopatoolis thrown in.
Then there was my graduation party, the one my parents did not attend.
I’m sure you have a few *ahem* hazy memories of your own.
Discover how you were studying complex expense concepts!
It’s true. You actually learned about running a business when you hosted a kegger. Or attended an all you can drink party with a flat admission charge. While there are obvious corollaries such as marketing (you had to get the word out right?), and branding (if it wasn’t cool, who would go?), you were getting tutored in expenses as well.
Well Nicole, I know I had to buy the beer, just like I know I need to purchase supplies now. Big deal.
Did you realize you were learning about fixed expenses, variable expenses and step expenses? Or how to include those expenses in your pricing?
Yes and you had fun doing it!
Let’s take a stroll down memory lane, and get a fresh understanding of our business to boot.
For every person at a party drinks would be consumed. For every additional person that came, additional beverages would be needed. There was a direct relationship between the number of attendees and the number of drinks required.
This is a great example of variable expenses. No matter how big your party, this expense will stay the same per person. If you know that each person consumes 5 beers on average you’ll need 50 bottles if there are 10 attendees. If there are 100 party goers you will need 500 drinks.
What are some common variable expenses in business?
- Time – Whether it’s your time, or an employee’s time, there is often a certain amount required to deliver on a service or manufacture a product.
- Commissions – Whether your sales are generated internally, or through a third party, the agents will expect to receive the same commission for this first sale as their 500th sale.
- Materials –
This is the easiest to include in pricing. It doesn’t matter how many or how few you sell. This cost will be constant for each product or service you offer.
While you weren’t expecting a Martha Stewart style spread, generally these parties had some food. Usually you would find chips, pretzels, and pizza. I’m not going to count the limes you used for Tequila shots.
While these expenses do increase when the number of people increases, it’s not a straight line. Let’s take pizza as an example. We’ll assume that on average one person would eat 3 slices of pizza during the party. Most pizza is cut to have 8 slices. Hmmm… that means you can feed 2.67 people with one pizza. Have you ever met a 0.67 person? Neither have I. Let’s see how this would work.
You have 9 people coming to your party. That means you will need 27 slices of pizza (9 * 3). It will require at least 3.375 pizzas (27 /8) to feed them. Unless things have changed dramatically since I went to college, Domino’s will not deliver 37.5% of a pizza. What will you do? If you only get 3 pizzas there won’t be enough (Quelle horreur!). If you get 4 pizzas you’ll have uneaten pizza afterwards. Of course you’re going to go with 4 pizzas, because if people are hungry they’ll leave the party.
Good news, a friend just called to say they can come after all. That means you’ll have a total of 10 guests. Will there still be enough pizza? You’ll need 30 slices (10 * 3) to feed everyone. That would require 3.75 pizzas (30/8) to feed everyone. You’re in luck, 4 pizzas will still be enough.
Even though the number of guests increased, our expense (pizza) did not. Of course if our expected headcount went up to 11, then we would need to order another pizza.
Why call them Step Expenses? Because when you graph them on a chart, it looks like a set of steps. The chart below represents our pizza example.
Headcount is the single most common step expense in business. You won’t need to add a new employee every time you add a new client, so its easy to see how it correlates to our pizza example. Also keep in mind, that even if you stretch yourself, you are likely to have capacity when you first add the new employee.
This can be more difficult to incorporate in pricing because you need to have a clear understanding of when to step up, and have a fairly accurate prediction of expected sales.
These expenses are also called overhead, G&A (general & administrative), or flat expenses. These are the expenses you have before the first client is won, and after the 1,001 client is won.
We’re going to head back to our party one more time. What are expenses that were incurred simply because there was a party? Some examples I can think of include; decorations, fliers,a Margherita machine, Karaoke equipment, even Pay Per View Costs (Think UFC). Hopefully a citation for noise was not on your list!
Examples of fixed expenses in business:
- The cost to file annual reports for the states in which you do business
- Annual Marketing Budget – even your PPC budget because there is no guarantee any of those click throughs will become sales
- Errors & Omissions Insurance for the year
The easiest way to determine if its a fixed expense is to ask your self two questions. Would I have this expense even if I have no clients? Will this expense remain the same this year, even if I grow by 100%? If you answered yes to both, it is a fixed expense.
Fixed expenses are very both hard and very easy. They are easy because they are general you know what they will be for the year. They are hard because you need to allocated them appropriately to your projected sales. If you overestimate sales, you could end up losing money because your pricing doesn’t reflect enough Fixed Expenses.
So what is a whapatooli anyway? A punch-like alcoholic beverage whose ingredients include beer, rum, vodka, Kool Aid®, 7-Up®, ginger ale, and chunks of fruit. Personally I think it was invented as a way to make a drinkable beverage from a hodge podge of ingredients.
Share Your Thoughts
How have you analyzed expenses in the past? How do you see incorporating the different types in the future?