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his chapter looks primarily at the costs associated with operating your business.
These can be divided into capital and current spending – also known as investment
and consumption. The accounting treatment of each one is slightly different.
Costs are usually split into functional areas (R&D, production, marketing and sales, etc.).
In accounting terms, production costs go into a manufacturing or trading account, and
all other functional areas are lumped together as operational spending in the rest of the
profit and loss account. Methods of analysing and forecasting costs for all functional areas
are identical and are considered together here.
Gross profit (Chapter 8) less operating costs (this chapter) leads you to net profit, or
net loss if times are tough. Just to complicate matters, there are several definitions of net
profit, which are discussed briefly. Then we can move on happily to discuss the critical
issues of cash flow and funding.
Where the money goes
Business sometimes seems to be a black hole that sucks in money. Understanding and
controlling costs is important. But naïve managers sometimes become obsessed with cut-
ting costs, often to the detriment of the business. As I comment elsewhere, spending can
be reduced by 100% maximum. Revenues could be increased to almost infinity. Spending
wisely to produce the maximum return is what it is all about. This chapter divides logically
into three parts.
1 Capital investment. First, take a look at capital outlays. This is basically spending
on assets with a life of more than a year. It is important, because it represents
cash spent today with the expectation of future reward. For this reason, capital
spending is singled out for close scrutiny.
2 Current consumption. Second, work through current spending. It is straightforward
if you break it into functional areas (R&D, marketing and sales) and then into
employment and other costs. These two categories divide further (travel, telephones,
computers, etc.). You can consider each in turn. The current part of capital outlays –
depreciation – is included here. Forecasting tricks are covered below.
3 Profit and loss. Third, pull this work together to build up a profit and loss account
and reach your bottom line – net profit or loss.
WHERE THE MONEY GOES 191
As already emphasised, the method you use to forecast operating costs is
identical to the approach for deriving production costs in the cost of sales
figures – see Chapter 8. It just happens that production costs are directly
related to sales and so receive special treatment by the men in grey suits.
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