Why you should check out a company’s running costs before investing

Julie Brownlee, Fsp Invest, 17 Aug. 2015

Tags: running costs, operational gearing, investing in shares, investing, high running costs,

When you research different companies to invest in, you’ll come across ones that have high running costs and ones that have much lower ones in comparison.

So does a company’s running costs make a difference? And is it something you should take on board when investing?

Read on to find out…

Working out a company’s running costs

Looking at a company’s running costs is something you should check out before investing. This is because it can make a big difference to a company’s profits.

It all comes down to operational gearing. Operational gearing determines how sensitive a company’s trading profits are to changes in its turnover.

Some companies will have to cover high running costs (fixed costs) whether or not they make a lot of sales. These running costs include salaries and renting out premises.

If a company has high running costs, it tends to have higher operational gearing.

On the other hand, if a company has lower running costs, it tends to mean it has lower operational gearing. This company has more variable costs instead.

Working out the impact of a company’s running costs

Let’s say Company ABC makes R30 million in sales. Its fixed costs come in at R24 million. And its variable costs are R3 million.

This means that Company ABC’s trading profit is R3 million (R30 million – R24 million – R3 million).

If the company sees its sales rise by 10%, this brings the total sales to R33 million. Fixed costs remain at R24 million and variable costs increase to R3.3 million.

This pushes its trading profit up to R5.7 million (R33 million – R24 million – R3.3 million). That’s an increase of 90%.

But if sales fell 10%, the company would see its profits nearly wiped out.

Why you need to pay attention to a company’s running costs

High running costs give high operational gearing. When a company is profitable and things are going well, this is fine. But if the company hits hard times, it means high risk for investors.

Making this worse is companies that borrow a lot of money too.

So there you have it. Why you should check out a company’s running costs before investing.

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