Small Business

Everybody knows what costs are until they try to define them. That is not altogether surprising because there are many different kinds of cost, and one cost concept may be suitable for a given purpose while another might not. In other words, there is no such thing as the cost of a good or service. The appropriate cost depends on the purpose to which it will be put.

In the first part of this chapter we discuss the factors to take into account when evaluating possible alternative courses of action. This will involve a consideration, inter alia, of the various costs and benefits associated with decision-making; in particular we shall be concerned to discriminate between those costs which are relevant in making any decision and those which are not. Opportunity cost, differential cost, variable cost, book value, etc., will be the ‘costs’ considered.

This chapter is concerned with capital expenditure in small businesses. Capital expenditure, which is expenditure typically on fixed assets such as plant and machinery, differs from other expenditure in two important respects. First, the benefits from the investment, whether in terms of labour savings or cash flow from additional profits, are likely to continue over a considerable number of years. Some technique is therefore needed to take account of the fact that cash flows in earlier years are more important than in later years. The principal reason for this is that cash received early on can earn interest and hence cannot be equated directly with an equivalent cash flow received later. Discounted cash flow (DCF) techniques do properly take this time value of money into account. Much of this chapter will be concerned with an explanation of these techniques within the context of small businesses. Second, the sums of money involved in the decisions are usually substantial and consequently more care needs to be exercised before committing the business to the purchase of the asset.