Here’s a problem I’d like to solve: technically, a break-even analysis is supposed to look at fixed costs as costs that would continue after a collapse, as in crash and burn. But practically, for planning purposes, that’s not the best thing to look at; I like the fixed costs to be the ongoing running costs that happen regardless of sales. I like to call that the burn rate. And it makes for a better break-even analysis.
This comes up because of an email question I received in the bplans.com ask-the-expert forum. It reminded me that I get this a lot, and it usually bothers me a bit.
Here’s the question in this case:
I am writing a Business Plan for a University. For the break-even analysis, I am not sure what to include in the variable and fixed costs. Could you suggest for me what a university might consider fixed costs in an “academic” service delivery?
Why it bothers me is because this is a good illustration of my problem with definitions.
- Technically, fixed costs would be what’s left over to pay, every month, after the university closes. That might or might not include left over payroll contracts, leases of land or equipment or whatever.
- However, despite the technical definition of fixed costs, what you should include, for practical purposes — and this is my opinion, not formal financial definitions — are the running costs that are incurred regardless of sales. That would presumably include all or at least most of the payroll of the university, all of the running costs associated with land and buildings, and maybe — this is a tough call — some of the running expenses for sales, advertising, and community development
Variable costs are the costs or expenses that your university pays that are directly related to students actually being there and taking classes. My guess is that these are relatively small: perhaps some contract instruction, higher utility bills, costs of serving food and maintaining housing facilities. I’ve never managed a university, so I just have to guess.
What does hold up in this suggestion is the division between the so-called “burn rate” fixed costs, running costs that don’t change according to the sales level, and the variable costs, that do change according to sales level. You have to make that distinction for yourself, usually, because I don’t know the details of your specific business.
And here’s a final warning: I hate it when the pragmatic right thing to do in a planning context is different from formal technical right thing to do. That leaves me and you vulnerable to having some outside expert point out that what I say is technically off.