MENDOZA, Alexis L. Josefina R.

Tan
BBTLEDIA 1-1 Business Finance for Entrepreneurs
Topic: Expense forecasting
Expense forecasting
An expense forecast estimates your ongoing operational costs over a
period of time. So any business, may it be a starting business, small or even
corporate business uses expense forecasting. To simply put, expense forecasting
predicts a business’ future expenses. unlike revenue forecasting, you foresee your
business' future expenses in order to make a decision for now. what to cut back,
or what else needs to be spent.
Costs vs. expenses
Costs – the amount spent by the business organization for the purpose of
acquiring an asset
Expenses – the amount spent by the business for ongoing operations in order
to secure the generation of revenue
The key difference between costs and expenses is that cost is a one-time
payment in nature for example fixed assets such as land, building, machinery and
etc. on the other hand, expense is a regular payment in order to secure a
revenue. for instance, depreciation, interest expense, raw materials expenses
and etc.
Defining costs
Expenses are the costs of being in business and providing a product or
service to a customer. In a business that sells products, expenses are generally
classified as cost of goods sold, selling, general administrative and other
expenses.
Cost of goods sold
Cost of goods sold represent the total cost to the seller.
 COGS = Beginning inventory + Purchases during the period – Ending
Inventory
The cogs also referred to as the cost of sales or cost of service, is how
much it costs to produce your products or services. Cogs include direct material
and direct labor expenses that go into the production of each good or service
that is sold. Remember that calculating cost of goods sold do not include the
indirect expenses in making your product or service like utilities or shipping fees.
For instance, you own a cabinetry company, examples of cogs would include the
woods, screws, hinges, glass, paint and labor to make the cabinets you sell.
However, the costs to market the cabinets like the electricity needed to
operate the machinery and shipping are not included in the cogs because those
would go in another type of expenses. To calculate your cogs you add whatever
left in your inventory from previous period to what you purchase during the period
and subtract it to whatever you did not sold sell at the end of the period.

Selling expense
Selling expenses represent costs related to selling the product. Remember
that any cost incurred to sell a product is a selling expense. A selling expense is a
cost incurred to promote and market products to customers. These costs can
include anything from advertising campaigns and store displays to delivering goods
to customers. This is where that indirect expense would fall into; the shipping
fee to deliver the cabinets you sell. Any expense that is associated with selling a
good or making a sale is considered a selling expense. Some typical example of
these are rent expense, store supplies and advertising in any form may it be thru
social media, a billboard advertising and etc.
General and administrative expense
General and administrative expenses are incurred in the day-to-day
operations of a business and may not be directly tied to a specific function or
department within the company. Legal Counsel Fees would fall in this category
and by that I mean, the fee you pay example for Auditors. Now, auditing teams
are the one who check financial statements made by accountants should come
from outside the company itself in order to check the financial statements
made without any agenda hidden. If the business really generate revenue or if
there is what we call it "kupitan" or stealing that happened.
Other expense
Other expenses are expenses not related to a company’s main business.
Typically, interest expense and any losses incurred would be included here.
Interest expense is those cost of borrowing money. It is the price the lender
charges the borrower for using the lender' s money.
Capital expenditure
Capital expenditures also represent a cost for companies. Capital
expenditures include the purchase of a piece of equipment or a building. Cost is a
one-time payment in nature and capital expenditure also represent a cost for
companies. Like the purchase of equipment, land or a building.
It is critical to accurately forecast your business' expenses as the
decisions made during the start-up and/or growth of a business venture relies on
it.

Cost behavior
Cost behavior refers to the relationship between total costs and activity
level. Based on behavior, costs are categorized as either variable, fixed or mixed.
Variable costs
Variable costs change in direct proportion to the level of activity of the
business. Activities that change variable costs can be very specific or can be as
general as the number of units being produced. Variable costs increase or
decrease depending on a company' s production volume; they rise as production
increases and fall as production decreases. Variable costs increase or decrease
depending on a company' s production volume; they rise as production increases
and fall as production decreases.
Variable Cost Graph

So as you can see here is a graph

for variable costs. On the left corner
you can see the costs in thousands and
under is the production units also in
thousands. This indicates that cost is
proportionate to units. To simply put, if
the production of units increases, the
costs of it also increases.
Example:
1 2
7 cakes 10 cakes 0 cakes
cake cakes

Costs of sugar,, milk,

P 250 P 500 P 1,750 P 2,500 0
flour, and butter

Direct Labor P 500 P 1,000 P 3,500 P 5,000 0

Total costs P 750 P 1,500 P 5,250 P 7,500 0

An example of these variable costs are costs spent on raw materials and
packaging, direct labor and advertising. For instance, let us say that it costs 750
pesos for a bakery to make a cake. 250 pesos for raw materials such as sugar,
milk, flour and butter and the direct labor to make to a cake is 500 pesos. A
total of 750 pesos each cake. Let us say that a bakery needs 2 cakes. Now for
the costs of making 2 cakes, it will cost 500 pesos for raw materials and the
direct labor for making two cakes will be a thousand peso. A total cost of 1,500
pesos for two cakes. And it goes on.
Fixed Cost
 The second basic type of costs, called fixed, remains constant in total
dollar amount within a relevant range of activity. That is, these costs do not
change with a given activity such as sales or units produced.
Unlike variable cost, fixed cost as it is called, it does not change with an
increase or decrease in the amount of goods or services produced or sold.
Fixed costs graph
Here, is a graph for fixed costs. You
can see that despite the quantity of units
produced is increasing, the cost remains
constant. Some example of these fixed
costs are salary, utility expense, legal
expenses, equipment rental and etc.

Under fixed cost there are two types, termed committed fixed costs and
discretionary fixed costs.
- Termed committed fixed costs
Committed fixed costs are costs that a business has already made
or obliged to make in the future; thus, they cannot be recovered. As a
result, committed fixed costs are difficult to alter at the discretion
of the management.
Example:
ABC Company is a furniture manufacturing company that plans to
undertake a new order which will result in a new net cash flow of
P1,000,000 within a period of one year. If the company proceeds to
take the above order and is already running at full capacity without
extra production capacity present, ABC will have to rent out extra
production premises for a year that will cost to P250,000.
Committed fixed costs may be a part of a legal agreement with a
supplier or a client, in which case, not honoring it may result in
 additional legal cost and reputation risks. This will be done by
entering into a contract with the landlord.
- Discretionary fixed costs
Discretionary fixed costs are referred to as period specific costs
that can be eliminated or reduced without affecting the profitability
directly. A discretionary fixed cost is also named as a managed fixed
cost.
The difference between termed committed fixed cost and
discretionary fixed cost is that termed committed fixed costs are like
long-term investment whereas discretionary fixed costs can be cut
back anytime but if cut back for too long generally exceeding for one
year, this will have an impact on the competitiveness of the business.
Example:
DEF Company has planned to conduct training for its
employees on quality and process improvement, and a cost of P150,000
was assigned for this from the last year’s budget. Due to some
unforeseen cost increases, the total cost structure of DEF
increased within this year where the company is compelled to save
funds wherever possible. Thus, the management decided to postpone
the employee training for some months.
Just like in the example, if DEF continued to postpone the
employee training for a year, this will result in lack of employee
training which will then result in declining employee effectiveness.
Mixed costs
Many costs do not behave simply as fixed or variable costs. Such costs are
termed mixed costs, as they have both a fixed component and a variable
component.
Mixed costs graph

Here in this
graph, both fixed
and variable costs
are present.

A good example for this is telephone or cellphone expense. You may be

charged a fixed amount a month for the text message, call duration and data
usage you are allowed to use. But when you exceed your limit, you are charged a
set amount (this is the variable cost) on each text message, exceeded call
duration and data usage you use over your limit.
It is also critical to identify the type of cost behavior as this allows the
manager to determine beforehand if any cost will decline or rise with the change
in the business activity.