What are you worth as professional contractor

Prepared by : SAPAC Reporter
Article Classification: Information
Image courtesy: SAPAC Professionals and Contractors

 

Get in contact with SAPAC:
 Visit https://sapac.co.za/
📑 Complete Form: Link (PRESS HERE) FOR SAPAC
[GOEIE INFORMASIE] SLUIT AAN! https://bit.ly/ActionSAPAC 

Areas: Southern Africa, Northern Cape, Western Cape, Cape Winelands, Free State, Gauteng, North West Province, Limpopo, Mpumalanga, Natal 

Did you know that with SAPAC there are trusted firms, that complies with regards to these requirements. To get in contact complete the form above. Further down in the article is much more information for you.

Operating Costs Definition: Formula, Types, and Real-World Examples

DISCLAIMER

Before we dwell into this, it is important to understand that this information does not constitute financial or legal advice. The information portrayed is intended for the different trades to understand their operational value and daily running of their businesses.

Tools that can be utilized for this exercise is a Microsoft Excel spreadsheet. Or the best alternative is to book an appointment with your Chartered Accountant or Book Keeper. Sit down with them and do perform this exercise.

Make time for your business and you will better understand the question of what you are worth. It will portray a unique definition towards yourself and your business operations. And it may assist you to make adjustments where required to maximize your business operational outputs.

The emphasis on this information is not to dissuade you or to over power you with information. However it is to provide you with a guideline of what you can do to understand your value better. Take the time to read and dissect this information. If you finish this article (take your time) there is some tips at the end for you to consider to implement some factors into your business if you have not done so yet.  

To save this information follow the prompt at the end of the article.

For a concise article on this information PRESS HERE 

How to estimate and find out what the cost of running your business is?

Operating expenses encompass the ongoing expenditures required for the regular functioning and management of a business.

These expenses comprise both the direct costs of goods sold : In this instance, we refer to as (COGS) 

(COGS) - Cost of goods sold, and additional operating costs, commonly referred to as selling i.e. , general, and administrative (SG&A) expenses.

SG&A  - Selling, General and Administrative expenses typically cover items like rent, payroll, overhead expenses, raw materials, and maintenance costs.

NB: It's important to note that operating costs do not include non-operational expenses associated with financing activities, such as interest payments, investments, or insurances. 

Operating costs are subtracted from revenue to determine operating income, and they are prominently displayed on a company's income statement.

What are the Key Take away notes to understand 

Operating expenses are the continual expenditures arising from the routine operations of a company.

Examples are: 

Materials: Cost of raw material, components, and supplies directly used in producing services

Labor: Wages and salaries of employees directly involved in the service solutions you provide.

Overheads: Rent, utilities, depreciation values, and other indirect cost directly related to services rendered. 

Remember what is (COGS) Cost of goods sold, and additional operating costs,
Remember what is (SG&A) Selling, General and Administrative expenses 

Note: These expenses Materials, Labor, Overheads consist both of (COGS) and additional operating costs, often categorized as selling, general and administrative (SG&A) expenses. So it is important to differentiate. 

Apart from (COGS) typical operating costs encompasses expenses such as rent, equipment, inventory, marketing, payroll, insurance and allocations for development.

Analysis of operating cost can be conducted by examining your company`s income statement.

Understanding Operating Cost in your Contractors Business

Professional Contracting Businesses must monitor not only their operating costs but also expenses related to non-operational activities, such as interest payments on loans. These costs are recorded differently in a company's financial records, enabling chartered accountants or book keepers to discern the connection between costs and revenue-generating activities and to assess opportunities for enhancing operational efficiency. It is crucial therefore to partner with the correct chartered accountant or book keeper.  

In general, all contracting company's management aims to maximize their profits. Profitability hinges on both the revenue generated and the expenses incurred to sustain operations, thus allowing for profit growth through increased revenue or reduced operating costs. Given that reducing costs appears to be a more straightforward approach to boosting profits, managers often prioritize cost-cutting measures.

Cost cutting measures  - Note it is highly advisable that you if you are indeed a professional Contractor not to cost cut on legal aspects. I.E. Worker Compensation (FEM) or Bargaining Councils, or book keeping services.

Excessively cutting operating costs can diminish a company's productivity and, consequently, its profitability. Although trimming any specific operating expense typically boosts short-term profits, it can also adversely impact the company's long-term earnings.

For instance, if a company slashes its advertising budget, it may experience a short-term profit increase due to reduced expenses. However, this reduction in advertising expenditure could hamper the company's ability to attract new business, potentially leading to diminished future earnings.

How to Calculate Operating Costs

The following formula and steps can be used to calculate the operating cost of a contracting business. You will find the information needed from your companies income statement that is used to report the financial performance for the accounting period. (Your business financial year)

Remember what is (COGS) Cost of goods sold, and additional operating costs,
Remember what is (SG&A) Selling, General and Administrative expenses 

Operating cost=Cost of goods sold + Operating expenses

To determine the total operating costs for a period use your company's income statement:

1. Identify the total cost of goods sold / services (COGS), also known as the cost of sales, from the income statement. (CREDITORS)

2. Locate the total operating expenses, typically listed further down the income statement. (DEBITS)

3. Add together the total operating expenses and the COGS to calculate the total operating costs for the given period.

Credits will be paid invoices, where debits will show fuel for instance or other sundries.

Types of Operating Expenses

While operating costs typically exclude capital expenditures, they encompass various elements of operational expenses, including:

1. Accounting and legal fees
2. Bank charges
3. Sales and marketing expenditures
4. Travel expenses
5. Entertainment expenses
6. Non-capitalized research and development costs
7. Office supplies expenses
8. Rental expenses
9. Repair and maintenance expenditures
10. Utility costs
11. Salary and wage payments

Additionally, operating costs encompass the cost of goods sold (COGS), which are directly associated with the production of goods and services. Some examples of COGS include:

1. Direct material costs
2. Direct labor expenses
3. Rent for production facilities
4. Benefits and wages for production personnel
5. Equipment repair costs
6. Utility expenses and production facility taxes

Your contracting business operating costs consist of two main components: fixed costs and variable costs, each with distinct characteristics.

What is Fixed Costs in your contracting company?

A fixed cost remains constant regardless of fluctuations in sales volume or productivity levels and must be paid irrespective of a company's performance. For instance, a manufacturing firm is obligated to pay rent for its factory premises regardless of its production output or revenue. While it may have the option to downsize and reduce rental expenses, it cannot entirely eliminate this fixed expense, thus rendering it immutable. Fixed costs typically encompass overhead expenses, insurance premiums, security costs, and equipment expenditures.

Fixed costs play a pivotal role in achieving economies of scale. When a substantial portion of your company's expenses is fixed, the firm can generate higher profits per unit as production volumes increase. Under this framework, fixed costs are spread across a greater number of units, enhancing production efficiency by reducing the average cost per unit. Economies of scale enable larger companies to offer goods at lower prices compared to their smaller counterparts.

However, the principle of economies of scale is subject to limitations. Fixed costs generally escalate as certain production thresholds are reached. For instance, a manufacturing company that boosts its production rate may eventually necessitate an expansion of its factory space to accommodate the heightened output.

Understanding variable costs. 

Variable costs, as the term suggests, consist of expenses that fluctuate in direct proportion to production levels. Unlike fixed costs, variable costs rise with increased production and decline with decreased production. Examples of variable costs include raw material expenses and electricity charges.

For instance, a fast-food restaurant chain that specializes in selling French fries must escalate its purchase orders for potatoes from suppliers to boost fry sales.

In some cases, companies may secure volume discounts or "price breaks" when procuring supplies in bulk. In such agreements, the seller may agree to reduce the per-unit cost slightly in exchange for the buyer's commitment to regular bulk purchases. Consequently, this arrangement can attenuate the direct correlation between production fluctuations and variations in operating costs.

For instance, the fast-food company might procure potatoes at R0.50 per kilogram for orders below 200 kilogram. However, the potato supplier may extend a reduced rate of R0.45 per kilogram for bulk orders ranging from 200 to 500 kilogram. While volume discounts may marginally affect the correlation between production levels and variable costs, the underlying trend typically remains unchanged.

The same principle can be applied by Hardware suppliers. Case in point someone may get hardware cheaper seeing that they buy in bulk perform more business than another contracting company.

Usually, companies characterized by a significant proportion of variable costs compared to fixed costs are regarded as less volatile. This is because their profits hinge more directly on the performance of their sales. Similarly, assessing the profitability and risk of such companies is generally more straightforward.

Understanding Semi-Variable Costs

Apart from fixed and variable costs, your contracting business operating expenses may also include semi-variable costs, sometimes referred to as "semi-fixed" costs. These costs entail a blend of fixed and variable elements, occupying a middle ground between fixed and variable costs. Semi-variable costs fluctuate partially with changes in "production" levels, akin to variable costs, but persist even when production is at zero, resembling fixed costs. This characteristic primarily distinguishes semi-variable costs from fixed and variable costs.

Overtime labor serves as a prime example of semi-variable costs. Standard wages for employees are typically categorized as fixed costs since, while management can adjust workforce size and paid hours, a certain workforce is essential for company operations. On the other hand, overtime payments are often regarded as variable costs because the number of overtime hours correlates with production fluctuations. However, when wages incorporate both fixed and variable components due to productivity-driven overtime conditions, the expense is considered a semi-variable cost.

Distinction between SG&A and Operating Costs

Remember what is (COGS) Cost of goods sold, and additional operating costs,
Remember what is (SG&A) Selling, General and Administrative expenses 

Selling, general, and administrative expenses (SG&A) are delineated on the income statement as the aggregation of both direct and indirect selling expenditures along with all general and administrative outlays of a company. This encompasses all expenses not directly associated with the production of goods or provision of services—essentially covering the costs involved in selling and distributing products or services, alongside those incurred in managing the company itself.

SG&A encapsulates nearly all expenditures not accounted for in the cost of goods sold (COGS). On the other hand, operating costs encompass COGS along with all operating expenses, which includes SG&A.

Challenges Associated with Operating Costs

Similar to any financial measure, it's essential to analyze operating costs across multiple reporting periods to discern any prevailing trends. Occasionally, companies may reduce costs for a specific quarter, leading to a temporary boost in earnings. Company owners need to vigilantly track these expenses to ascertain whether they are consistently rising or declining over time, comparing apples with apples, these findings with revenue and profit performance can give you an indication.

Understanding the Total Cost Formula

The total cost formula merges a company's fixed and variable expenses to determine the overall cost of producing a specific quantity of goods or services. To compute the total cost, add the average fixed cost per unit to the average variable cost per unit, then multiply this sum by the total number of units.

The significance of the total cost formula lies in its utility for management in assessing the profitability of their operations. It enables managers to identify which fixed or variable costs could potentially be minimized to enhance profit margins. Moreover, the formula aids in setting optimal price points for products and facilitates comparisons of the profitability between different product lines.

Impact of Operating Costs on Profit

Elevated or escalating operating costs can diminish a company's net profit. To mitigate this effect, management endeavors to stabilize or decrease operating expenses while ensuring the production or services aligns with consumer demands in line with expected operational standards. If operating costs soar excessively, management might contemplate raising product or service prices to sustain profitability. However, this strategy carries the risk of losing customers to competitors offering similar goods at more competitive prices. It is therefore crucial to understand your market and find a solution towards lifting you above competition. There are certain ways to perform this.

Distinguishing Between Operating Costs and Startup Costs

Operating costs encompass the expenses that a business regularly incurs during its day-to-day operations. Conversely, startup costs refer to the expenses that a new business must bear as part of the process of launching its operations. Even before a business commences its activities or introduces a new product or service to the market, it incurs initial expenses to establish itself.

For instance, these costs may include expenditures on research and development, equipment procurement, leasing office space, and paying employee salaries. Typically, startups finance these expenses through business loans or investments from private backers. This stands in contrast to operating costs, which are funded through revenue generated from sales.

The big question what are you worth is a feasible question that every contracting firm should ask. Identify shortfalls and adjust accordingly to accommodate for market fluctuations.  

So what are you worth and is your hourly rate justified?

All things considered, if you have established what you are worth and you have justified your hourly rate. You can now establish what set you apart within your specific discipline.

However an important factor to remember because you are a professional contractor is to envision the future. And to ask specific questions relating to your family's well being and towards your business.

a) What will happen if I am not here anymore for my family.
b) What happens to the business, will this business be able to operate without me?
c) Will my family be taken care off?
d) What happens to my business debt?
e) What happens to my personal debt?
f) What happens to my children? 

To answer these questions you are more than welcome to lodge an expression of interest to join SAPAC - Professionals and Contractors Collective. And to find out more by pressing this link (PRESS HERE) 

10 Tips to consider to implement if you have not done so all ready 

1) Ensure your bank send you your monthly bank statements. Print these and file them accordingly. It will showcase your credits and your debits. 
2) Always where possible utilize your business account card for purchases, keep the pin safe and have your banker on speed dial. It is advisable to disable your cards tapping function with your bank. (security is paramount)
3) Ensure all invoices have unique tracking numbers, and request on your invoices clients to make payments utilizing your unique tracking number on the proof of payment. (pop)
4) Print invoices and place paid invoices with proof of payments.
5) Utilize an external hard drive, create monthly folders for the entire year. Save your invoices and proof of payments under the corresponding months. 
6) Create a folder for received bank statements and also save them accordingly per month.
7) When you send bank statements or income tax certificates of your business to your chartered accountant or book keeper. Ensure that you keep a record of the emails as back up. 
8) Capture client data in an excel spreadsheet including the type of job you performed for them. If there is any certification that you issued. Scan and save these under their client file.
9) Utilize a Gmail account for backing up legal documentation in Google drive. 
10) Perform a yearly backup of your Hard Drive. And store such hard drive in a safe that is free from Magnetic interference. Note: Magnetics wipes data from external hard drives. 

What can I do to save this information?

You may re-share this information or you may make a shortcut to your desktop or mobile phone in the following manner. Seeing that these are continuously updated.

SAPAC Professionals and Contractors is national in all South African provinces.

Further Reading:

- Google, SAPAC.co.za Trust Matters

JOIN SAPAC