Understanding Fixed and Variable Expenses for Business Success

Understanding Fixed and Variable Expenses for Business Success

To create a robust budget for a service business, especially one with seasonality, you need to differentiate between fixed and variable expenses. This approach will help you manage your finances effectively and adapt to changing circumstances.

Example Profit and Loss Statement

Let’s assume a simplified P&L for an HVAC solopreneur for the past 12 months:

1. Sales: $300,000 (100% of total sales)
2. COGS: $75,000 (25% of total sales)
3. Gross Profit: $225,000 (75% of total sales)
4. Operating Expenses:
• Accounting: $3,000 (1%)
• Advertising: $15,000 (5%)
• Contractorst: $25,000 (8.3%)
• Insurance: $6,000 (2%)
• Licenses and Permits: $3,000 (1%)
• Office Supplies: $2,000 (0.7%)
• Rent: $12,000 (4%)
• Supplies: $20,000 (6.7%)
• Tools: $5,000 (1.7%)
• Utilities: $5,000 (1.7%)
• Vehicle: $20,000 (6.7%)
5. Net Profit: $109,000 (36.3% of total sales)

Understanding Fixed and Variable Expenses

1. Fixed Expenses: These are costs that do not change with the level of production or sales. Examples include:
• Accounting: $250/month
• Insurance: $500/month
• Rent: $1,000/month
• Utilities: $417/month
• Vehicle Payment: $800/month
• Website Costs: $50/month
• Advertising: $500/month
2. Variable Expenses: These costs fluctuate with your business activity. Examples from the HVAC business might include:
• COGS (Cost of Goods Sold)
• Contractors
• Supplies
• Tools
• Vehicle Expenses (Fuel, Maintenance)

Budgeting Strategy to cover fixed expenses

1. Identify Fixed Expenses: Total monthly fixed expenses are $3,517. Annually, this totals $42,204.
2. Determine Monthly Requirements:
• Fixed expenses: $3,517/month
• Total needed: $11,517/month to cover fixed expenses and variable expenses on the sales.
3. Variable Expenses: These account for 35.6% of sales, plus the profit/owners draw of 34.3%.

Analyzing Sales and Profit with 100% growth projection profit more than doubles!

1. If the business doubles sales to $600,000, fixed expenses remain the same at $42,204 annually.
2. Variable expenses will double.
3. New Net Profit Calculation:
• Fixed Expenses: $42,204
• Variable Expenses (remains the same 24.6%): $147,600
• Total Expenses: $189,804
• Gross Profit: $450,000 (75% of $600,000)
• Net Profit: $260,196 (Gross Profit – Total Expenses)

Key Takeaways

1. Seasonality Management: Understanding your fixed and variable expenses help manage seasonality. Fixed expenses must be covered regardless of sales volume.
2. Sales Growth: Variable expenses increase proportionately. Doubling sales will more than double profit due to the fixed costs involved.
3. Sales Decline: Fixed expenses cause a decline in sales to decrease profit margins, even if variable expenses remain the same percentage.
4. Financial Cushion: Maintaining a savings buffer for months when sales are lower than average is crucial for stability.
5. Consistent Monitoring: Regularly review your profit and loss statement to adjust your budget and ensure you remain on track financially.

By keeping a close eye on your fixed and variable expenses, you can make informed decisions that prevent insolvency and capitalize on growth opportunities. This proactive approach to budgeting will help you navigate the cyclical nature of your business effectively. To help you manage your finances and ensure business growth, Remote Accounting Payroll and Tax offers comprehensive services. We specialize in tracking profit and loss, creating budgets, and analyzing financial reports. Our experts will help you manage expenses, mitigate risks, and seize growth opportunities. Let us handle your financial management so you can focus on running your business. Contact us today to learn more about how we can support your financial success!