So, what is the Cost of Doing Business?

Cost Of Doing Business September 21, 2020

Lauren Christiansen

Writer

Running a successful small business is an expensive endeavor. Between operating costs, labor, utilities, and equipment purchases, there are several expenses to account for. Calculating exactly how much is spent to keep a business running allows owners to plan while consistently increasing revenue.

Here's a look into various business costs that play a role in determining a brand's profitability.

What Does the Cost of Doing Business Mean?

The cost of doing business (CODB) refers to all the expenses incurred while producing or selling goods and services. Expenses are either-

Direct Costs
Direct costs are directly related to a cost object, which can be identified as a product, department, or project. Examples of direct costs include raw materials, labor, or software.

Indirect Cost
Indirect costs are items that contribute to running and maintaining a company but are not related to the creation of a product or service. Examples include building security, utilities, office equipment, or rent.

Managers, owners, and other stakeholders have to carefully consider direct and indirect expenses because they affect the company's profitability. If the profit margin isn't large enough to compensate for the cost of doing business, then this affects the company's ability to survive.

Cost of Doing Business- Important Terms

To calculate the cost of doing business, it's important to be knowledgeable of the following terms-

Non-Reimbursable Expenses
Non-reimbursable expenses refer to anything that the company has to pay for itself to maintain operating. These expenses are non-deductible, which means that the company cannot subtract them from its taxable income on an income statement. Non-reimbursable expenses include rent, computers, insurance, office supplies, utilities, or equipment, startup costs, registration, and licensing costs, office rent, labor, advertising.

Desired Salary
An ideal income will become attainable to owners in time, but until the business becomes profitable, they must sacrifice a desired salary for the company's operational costs. In order to determine individual earnings, monitor net profit monthly, and keep in mind that the goal is to set the business up for long-term success.

Billable Days
This includes all of the days in one year a business is open to sell its product or service.[MJ1] [MOU2] Calculating the billable days allows businesses to assess exactly how much it costs to remain in operation. Businesses can pinpoint which expenses are essential and where to cut costs. It also helps to create a detailed and accurate budget that outlines the current state of expenses and revenue.

Calculating Operating Costs

Owners can calculate operating costs by using the following equation-
The Cost of Doing Business = Non-Reimbursable Expenses + Desired Salary / Number of Billable Days

For example, a small retail shop owner calculates the CODB-
Non-Reimbursable Expenses- $8,000
Desired Salary- $40,000
Number of Billable Days- $262

Cost of Doing Business- $40,000 + $8,000 / 262 = $183.20 Per Day

Business Expenses

Business expenses are the economic costs a business accumulates while operating. Business expenses need to be included on an income statement, which is used to report a company's financial performance to the IRS. Business expenses are subtracted from revenue to show taxable income.

It's important to know what qualifies as a business expense, as deducting the wrong expenses on an income statement may lead to a fine. Personal expenses cannot be listed as a business expense. Read the IRS Rules for Deductibles for clarification on what constitutes a business expense.

Some examples of short-term business expenses include-

Payments to suppliers
Factory leases
Depreciation of equipment
Employee wages

Examples of capital expenses, or long-term business expenses, include-

Business startup costs
Real estate
Company vehicles
Patents
Equipment
Office improvement costs

Product Expenses

Product expenses are a bi-product of business expenses. They refer to the indirect or direct costs of manufacturing a product and making it available for sale. Costs include labor, materials, and any additional overhead expenses. Product expenses can be broken down further into two groups-

Conversion Costs The cost of converting raw materials into a final product
Prime Costs The cost of the materials themselves plus the cost of labor

Period Expenses

Another bi-product of business expenses, period expenses are any incurred expenses unrelated to production. Because period costs are not assigned to one particular product or cost of inventory, they are listed as an expense in an income statement. If a period cost is an economic benefit for more than a year, it can be written off over a period of years.

Examples of period costs include-

Legal or professional fees
Office Supplies
Utilities
Marketing Expenses
Maintenance and Repairs
Travel, Entertainment
Salaries and Employee benefits
Insurance
Loan interest and liabilities
Vehicle Expenses

Best Practices for Calculating the Cost of Doing Business

1. Estimate Expenses Correctly
Expenses can rise as a business grows. Don't forget to re-calculate costs regularly and include any additional variable costs.

2. Understand Costs
Remember to include all costs, including one-time and ongoing expenses. If a large expense is made one month, then the money going out will be greater than the money going in. On the other hand, ongoing costs do not fluctuate as much from month-to-month.

3. Organize & Use Proper Tools
There are many available online CODB tools and spreadsheets to help organize and calculate business expenses. Use any tools possible to make it easier to perform calculations.