1 st Bach - Financial Concepts

 Financial Concepts

The economic management of an entrepreneurship has to do with key concepts such as: income, costs, expenses and investment. Knowing these concepts is important for the entrepreneur to calculate the break-even point and to make financial projections.

Income

Is the money that the entrepreneurship receives from the sale of goods and services developed to be sold in the market. To calculate the level of income (daily, monthly, annually or any other period) it’s necessary to know about the price and quantity of sales of the product. 

(Example: If a bakery sells 200 pieces of bread daily for 0.20 cents their daily income is $40)

Costs

It has to do with the money the entrepreneur gives to the suppliers in exchange for goods or services. These costs, as the main characteristic, are related to the production area of the business. 

(Example: In a bakery, flour and eggs are an example of costs because those are used to make the bread)

Expenses

They are related to the cash outlay from the entrepreneur for goods and services used to carry out commercial and administrative tasks. The interest payment of a loan is also included in expenses.

(Example: To make flyers for publicity. To pay the person in charge of accounting)

Investment

It’s the cash outlay that the entrepreneur uses for certain goods, mostly before the business can start running. The investment can be divided into fixed (fixed: machines, equipment, furniture, land, buildings, cars, etc.) and operational (money equivalent to the needs of at least three months to buy raw materials, pay salaries, give credit to customers, etc.). 

(Example: In a bakery, the money spent in an oven is a fixed investment, the money deposited in the bank at the beginning of the business used to buy flour is an operational investment)

Break-even point

When the entrepreneur has info about incomes, costs, and expenses, the break-even point can be calculated. This is the lowest sale level that has to be reached so there isn’t any gain or loss. Financially, every range of sales over the break-even point means that there is a gain.

The break-even point is the number of units sold at which a company's revenues equal its costs and expenses. In other words, it is the level of sales at which there is no profit or loss.

It is determined by the amount of sales needed to cover total production costs, and can be calculated with the following formula:

Break-even point in units = Total fixed costs / Unit contribution margin

The unit contribution margin is the difference between revenues and variable costs. Thus, the above formula could be rewritten as follows:

Break-even point in units = Total fixed costs / (Unit selling price - Variable cost unit.)

If the company knows its break-even point, it will be able to determine with certainty the level of sales needed to cover all expenses and start making a profit. Conversely, if sales do not reach the break-even point, the company will make a loss.

Example :

A company produces a computer that it will sell to the public for $900 each. The variable cost to produce each computer is $550 and the fixed cost is $30,500.

Data

Selling price: $ 900 each

Variable costs: $ 550 each

Total fixed costs: $ 30 500

Break-even point = TFC / USP - VCU

Break-even point = 30 500 / 900 - 550

Break-even point = 87.14

Financial Projections

They are the calculation for the future accounts that contain income, costs, expenses and investment. This can be done for a month, a trimester, a semester, a year or any other time period.