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HANDBOOK FOR FINANCIAL ANALYSIS IN CULTURAL SECTOR

Hristina Mikić

The Economy of culture

UNESCO chair for cultural management University of arts, Belgrade

2011.

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FINANCIAL ANALYSIS

Financial analysis is a tool of financial management intended for evaluation: project financial performances or institution/organization financial performances or government system of financing. Financial analysis is financial evaluation of project, yearly (monthly, quartile) activities of institution or government body. Usually, financial analysis is directed to analyze three main aspects of operating activities: 1. Profitability - earning power of cultural institution or market orientation of cultural institutions. 2. Liquidity - ability of cultural institution to cover all financial obligations at the proper time. 3. Capitalization - market value of cultural institution (this aspect can be analyzed in holding companies or stock companies e.g. creative industries) 4. Financial structure – financial structure of cultural project or financial structure of cultural institution Analysis of financial structure of cultural institutes is aimed to present structure of financial resources which are use for financing work of cultural institutions: self/ generated income, market income, grants, sponsorships etc. Analysis of financial structure of cultural project is aimed to present structure of financial resources used for financing project activities. Aims of financial analysis: - to understand the financial conditions of project, organizations

etc. - to make financial decision easier, - to understand financial risks (before realization of programme

activities or projects), - to evaluate financial performance trends, - to inform internal or external users concerning financial

performances, - to manage long-term or short-term financial policy - to manage policy of project-financing activities General principles of financial analysis/ final result of financial analysis should be:

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- UNDERSTANDIBLE: financial analysis has to be understandible. It should give real pictures of character of project activities as well as its specific aspects. Revenue and expenses should be present in group with a clear explanation (e.g. salary expenses, programme expenses etc.).

- - RELEVANT: financial analysis has to be relevant: revenues and

expenses with small value/amount do not present separately (e.g. if the phone expenses is 10 euros, this expenses will be presented as a part of operating expenses or with the similar type of expenses: expenses of communications (postal expenses, phone expenses and other expenses connected with communication).

- - CAREFUL: this principle should be apply for financial analysis

which is based on planned value. For example, if we plane to analyze financial performances of planed activities or established new cultural organization, it will be necessary to make projections of revenues and expenditures, and then to make financial analysis of planed financial values. In this situation you will plane carefully revenues and expenditures: revenues will be planed on low value (e.g. we request grant from Ministry of culture in value of 10.000 euros, but we know that usually get from Ministry of culture 50% of requested amount, so we will plane revenue of Ministry of culture in value of 5.000 euros), and expenditures should be plane on higher value.

- - RELIABLE: financial analysis should be reliable. All financial

value as well as financial indicators should be projected or calculate on credible information (e.g. for calculations and projections we should use official plans or documentation: we will use financial statements for calculating financial performances, etc).

There are different categories of financial analysis.

Depending of scope of financial analysis there are two categories of financial analysis: 1. Microeconomic financial analysis 2. Macroeconomic financial analysis Microeconomic financial analysis – financial analysis on a micro level: project, organization, institution, enterprise, government body etc. (e.g. Analysis of economic resources of one cultural institution/organization, Analysis of financing policy of Ministry of culture etc);

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Macroeconomic financial analysis - financial analysis on macro or mezzo level: government, state, local community, region, sector etc. (e.g. analysis of a system of financing and mechanism of budget distribution for cultural sector of the city of Belgrade; Analysis of financing cultural institutions in Serbia). Financial analysis can be: Static financial analysis - when we analyzed only one year. It offer information concerning planning and realized financial resources, financial result etc. Dynamic financial analysis - when we analyzed financial performances over a time period (two last years, three years etc.) Partial financial analysis – financial analysis aimed to one or several aspects of activities of cultural institution / project (e.g. you can analyze only profitability of cultural organization, market orientation of cultural institution etc, or only analyze one group of expenses or revenues: programme expenses, revenues of government bodies etc) Complex financial analysis – financial analysis aimed to all business activities and their financial position (profitability, liquidity or capitalization). Inter-sector financial analysis represents financial analysis which compares financial indicators to different cultural sectors or average for certain cultural field (e.g. all museums in Serbia). The aim of this kind of financial analysis is to identify and explain financial position of analyzed cultural institution and competing cultural organizations or average financial situation in the certain field of cultural activities. Financial analysis of financial trends represents financial analysis which compares current financial performances with previous ones. The aim of this kind of financial analysis is to identify and explain financial trends and direction of financial policy.

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MAIN STEPS IN FINANCIAL ANALYSIS:

1. step: organizing, adapting and groping revenues and expenditures for financial analysis

2. step: calculating and explaining financial indicators 3. step: preparing financial Feasibility Analysis Matrix 4. step: making general conclusion and recommendation

There are three financial reports which usually make set of annual financial reports (in Serbian language known as ZAVRSNI RACUNI)

1. Income statement (bilans uspeha) 2. Balance sheet (bilans stanja) 3. Cash flow report (izvestaj o novcanim tokovima)

Income statement is financial report which shows revenues, expenditures and financial result of cultural organization in one year. The aim is to show financial result of cultural organization. Balance sheet is financial report which shows state of capital (land, building, equipment) and liquidity goods (cash money, money on bank account) and sources of capital and liquidity goods (capital of owner, bank credits etc). The aim is to show state of assets of cultural organization. Cash flow is financial report which shows influx of money and flowing of money in one period of time (at the end of year). The aim is to show liquidity of cultural organization. Financial analysis can be based on information from annual financial reports or on information from individual budgets or analytical financial documentation.

Budget

Budget is list of expenses and revenues over a time period. It is useful tool for projecting how much money you will need for a major initiatives and activities. There is different kind of budgets: Operating budget – 1 year Capital budgets (for major assets, such as equipment, buildings, etc.) Project budget -detailed budget for project or programme activities

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OPERATING BUDGET CONSIST OF: Salary expenses + personal development expenses + capital expenses (only for concrete year) + running expenses + marketing expenses + programme expenses

Management plan – salary expenses Salary expenses (in euros)

Position

Number of

person Units/ month

Total salary

cost per month

Yearly expenses

Executive director 1 12 810 9720

Manager 1 12 672 8064 Project assistant 2 7 401 2807

Total 5 1883 20591

Personal development plan and capacity building (personal development expenses)

Item Number of person

Description Cost per person/ flat rate

Yearly expenses

Activity 1 10

Improvement management

skills 60* 600

Activity 2 15

Language courses 700 700

Activity 3 Activity 4 TOTAL 5 000

cost per person

Capital investment plan – Investment expenses

(equipment, building expenses etc) Capital investment plan (fixed assets) A) Equipment

Item trademark Pieces Cost per unit

Total capital expenses

PC Fujitsu 5 800 4000 Printer Fujitsu 2 200 1600 TOTAL 5600

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B) Buildings

Item Description Cost per unit Total capital expenses

Object 1 building service Object 2 reconstruction TOTAL Running expenses plan Operating expenses - rent, utilities, communication, office supplies, maintenance and office expenses, taxes & bank charges, legal expenses, other expenses)

Item Number of units

Cost per units

Total expenses

Rent 12 150 1800 Utilities (electricity, heating)

12 100 1200

Communication 12 70 840 Office supplies Flat rate 1500 1500 Maintenance equipment Flat rate 700 700

Tax and Bank charges Flat rate 300 300

Legal expenses Flat rate 1000 1000 Travel expenses Flat rate IT service Flat rate 500 500 Insurance 12 50 600 Other expenses Flat rate 1500 1500 TOTAL 9940

Marketing plan – marketing expenses

Item Description Yearly expenses

Marketing activity 1 Marketing activity 2 Marketing activity 3 Marketing activity 4 TOTAL 5 000

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Programme expenses plan Direct and indirect costs of program realization

Item Total Programme

Expenses Programme 1 5000 Programme 2 6000 Programme 3 4000 Programme 4 4000 TOTAL 19000

Expenses plan/ statement– Summary Item Amount

2005 % of total

expenses

Amount 2006

% of total expenses

Change 2006/2005

Personal expenses (1+2) 25591 39% 1. Salary expenses 20591 2.Personal development expenses 5000 Capital expenses (fixed assets) 5000 7,75% 1. Equipment 5000 2. Building - Running expenses 14940 1. Operating expenses 9940 2. Marketing expenses 5000 Programme expenses 19000 TOTAL 64531

Comment: -Explain the structure of costs -Compare structure of cost with other cultural organizations (or usual costs structure of cultural organizations). You can use information from: Statistical Year Book (comparison structure of cost with average cost structure of all institutions or with cost structure of institutions in the certain field), from Budget of the Ministry of culture (comparison structure of cost with average cost structure of all institution financed by Ministry of culture ) -Explain how will be covered planned expenses Simple example:

In the structure of operating costs the main item is salary expenses. Salary expenses are estimated on the basis that 90% of employed persons will be with bachelor degree and those expenses will be covered by Government contributions – Ministry of culture. The programme expenses represent 29% of total expenses and those expenses will be covered by sponsorships and government contributions. The fixed assets investment represents about 7,75 and those investments will be covered by business contributions (COM TRADE Company) and subsidies of Ministry of cultur

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Income statement – income resources

The list of potential or available financial resources. Basically, it presents the nature of your overall profit and loss over a period of time. Therefore, the Income Statement gives you a sense for how well the nonprofit is operating.

Resources of financing Amount (2009)

% OF TOTAL

Amount (2008)

% OF TOTAL

Changes 2009/2008

The Ministry of culture 70000 79,5% 90000 83,3% 28,57% The Ministry of science 5000 5000 The Ministry of education 0 0 Sub total: Government contributions 75000 75000 International funds and grants 0 0 Individual donations 0 0

International foundations 1000 1000 Corporate donations 0 0 Sub total: Donated contributions 100 100 Sponsorships 5000 5000 Business supports 3000 3000 Sales (tickets, services, product sale etc) 4000 4000 Sub total: market contributions 12000 12000 TOTAL 88000 108000 Total expenses 64531 64531

Income gap /surplus (Gross profit) 23469 23469 Non taxable amount of profit (Serbia) 3 750 3 750

Profit Tax 10% 1971 1971

Net profit 21498 21498

Comment: -Identify trend line in revenue flows (e.g. grow in fundraising resources, reducing government subsidies etc), if you analyze financial performance for a few years.

- Explain the structure of different categories of financial resources over the analyzed time. - Explain final financial result (income gap or surplus)

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Financial analysis techniques

1. Financial ratios Financial ratios (indicators) are used to evaluate financial and economic results of activities/operations over a given accounting period. There are two kinds of financial ratio analysis:

1. Partial ratio analysis – if we analyze some financial performances of long-term project or organization

2. Complex ratio analysis – if we analyze all financial performances of long-term project or organization

COMPARAISON: 1. Financial indicators can be compare to different cultural activities/sectors or average (for comparison, you can use data from Statistical Year Book or other available resources e.g. financial statement of some cultural organization) 2. God way to compare financial indicators is by comparing current ratios with previous ones (if you have financial data for a few years) RATIO CATEGORIES: There are a variety of ratios that can be used to help determine the current and future condition of a nonprofit. The ratios are produced from numbers on the financial statements. Note that the usefulness of ratios often are from comparing ratios from different time periods in the same cultural organization or from standards for a type of cultural organization, e.g. museums, theaters, libraries, visual arts etc.

1. Liquidity ratios – identify the relationship between current assets and current liabilities. Indicates ability to meet short term obligations to repay debt.

2. Profitability ratios – the profitability ratios show management’s

effectiveness in using assets/different kind of financial resources

3. Market capitalization ratios – analyzing item oriented with market value

of shares (this group of ratio can be used for holding companies or stock company e.g. creative industries)

I Financial ratios

1. RETURN ON TOTAL ASSETS. ROA is net income before income taxes divided by total assets. This figure shows the productivity of assets, or, in other words, how much income is earned for each dollar of asset. This ratio provided information about earning power of assets of cultural institution. This is very important ratio for enterprises in creative industries.

RETURN ON TOTAL ASSETS = net income (profit)

Total assets Total assets – you will get information for balance sheet Net income – you will get information for income statement

2. PROFIT MARGIN ON SALES 1: This ratio, net income divided by net income from sales indicates the amount of net income generated by a euro of sales.

revenuessales

incomenetMARGINPROFIT 1

3. PROFIT MARGIN ON SALES 2 (MINUS SUBSIDY): The same as above,

we include this ratio minus the subsidy in order to compare the position of the organization/enterprise before and after allowance for non-profit subsidies. By comparing these two related ratios, one can assess whether the enterprise is profitable, in general terms, with or without subsidy. This indicator informs us about relative “marketability” of cultural organization operations.

PROFIT MARGIN ON SALES =subsidiesincomeessbu

incomenet

sin

4. MARKET INCOME RATIO: measures market orientation of cultural

organization as well as trends in current financial policy

MARKET INCOME = incometotal

incomemarket

Market income= sales income, sponsorships, business contribution Orientation value:

> 0,5 - strong market orientation of cultural organization = 0,5 – mixed financial resources < 0,5 – poor market orientation, domination of government resources

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It would be good to compare market income ratio of cultural institution with this ratio of main competitor or with average.

SIMPLE EXAMPLE: In 2006, income structure (income statement) of all museums in Serbia was following: Market income –1 135 500 euros (9,13%) Government subsidies – 10 475 425 euros (84,26%) Other income and donated contribution – 821 0 75 euros (6,61%) TOTAL INCOME 12 431 500 euros (100%) In 2006, income structure of Museum of contemporary art was: Market income –72 125 euros (4,51%) Government subsidies – 1 500 000 euros (93,92%) Other income and donated contribution – 25 000 euros (1,57 %) TOTAL INCOME 1 597 125 euros (100%) In 2005 income structure was: market income 80 000 euros (4%), government subsidies 1 880 000 (94%), and other income and donated contribution 40 000 (2%). Calculate and describe market orientation of Museum of contemporary art. Market Income ratio (Museum of contemporary art) = (market income/ total income) x 100% = 4,51% Market income ratio (museums in Serbia) = 9,13% COMENT: Serbian museums have a poor market orientation. In the income structure of all museums government resources are dominant (93% of total income coming from Government and state funds). Market income ration of Museum of contemporary art is 4,51% which indicates poor market orientation compare to usual standard as well as average of Serbian museums. Financial policy of Museum of contemporary art can be describe as defensive financial policy because there is no active measures and instruments to attract alternative financial resources or to compensate decreasing state subsidies. We identify defensive approach by comparing structure and level of financial resources in the last two years. Compare to 2005 there is decreasing of state subsidies for 20% (380 000 euros) and this financial gap was not compensated with alterative financial sources. In the same time, market income decrease for 10%. Reducing of market income is caused by smaller programme activities and number of sponsor.

SIMPLE EXAMPLE: If you have information, you can calculate market contribution of cultural organization.. In 2006 all museums in Serbia realized 1 135 500 euros (90 840 000 dinars) market income (sale revenues, business contribution, revenues from sponsorships). In 2006 the Museum of contemporary art in 2006 realized 72 125 euros (5 770 000 dinars) market income. Calculate market contribution of Museum of contemporary art? Market contribution = market income of Museum of contemporary art/market income of all museums in Serbia x 100% Market contribution of the Museum of contemporary art = (72 125/1 135 500) x 100% = 6,35%. COMENT: In 2006 worth of museum market was 1,13 mills. Euros, out of which 72 125 euros was realized by the Museum of contemporary art. Market contribution of the Museum of contemporary art was 6,35%.

5. SALES INCOME RATIO measures earnings power of cultural organization

SALES INCOME RATIO = incometotal

incomesales

Sales revenues = services, tickets, products, etc. High sales income ratio indicates market penetration of cultural organizations and management’s effectiveness in its use of market potential. Lower ratio indicates that management is not effective in market penetration or some of market potentials are not exploited.

COMMENT: After calculating sale income ratio, you should explain reason for low/high level of sale income ratio; if you have information, you can make comparison with other cultural organizations. Describe possibility for market penetration or market potential that are not exploited.

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SIMPLE EXAMPLE: In 2005 sales income was 20 000 euros, in 2006 sales income was 15000 euros. SALE INCOME RATIO (2005) = (20 000/ 2 000 000) x 100% = 1% SALE INCOME RATIO (2006) = (15 000/ 1 597 125) x 100% = 0,94% COMMENT: In the last two years, the sale income ratio is on the quite same level with slowly, but decreasing tendency. The low level of sale income ration is caused because of introducing new audience development programme. In 2004, The Museum of contemporary art was faced with decreasing number of visitors (2500 visitors). In the same year average attendance per programme was 100 visitors, so management of the Museum decided to define and introduce programme for audience development. The main element of audience development programme is exhibition entrance without fees and for special programme entrance fees with discount for students and teenagers, so until 2008 there is no possibility for increasing this kind of financial resources. In the same time, this decision is directed to increase market penetration of the Museum activities as well as to increase sale potentials in the future. SALES INCOME RATION PER AUDIENCE: measure efficiency of earning power of cultural organization. This ration should be compare with the same indication on the expenses side, to identify balance or misbalance between cost growth and market growth.

EXPENCES RATIO per audience= running expenses + personal expenses Number of audience

SALES INCOME RATIO per audience = audienceofnumber

incomesales

6. FUNDRISING MARKET INCOME: indicates cultural organization power for fundraising and cooperation with business sector.

FUNDRISING MARKET INCOME = incometotal

totalresourcesgfundrai sin

Fundraising resources = business supports (in kind contributions, corporate donations, sponsorships, individual donations, etc. This ratio indicates the amount of fundraising income generated by a euro of total income.

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If you have information, you can modify this ratio and analyze analytical items in DS and BS categories (for example: fundraising resources by international foundations vs. total income) as following: Fundraising resources BS (business supports) = contribution by business supports (in kind contributions, corporate donations, sponsorships, etc. Fundraising resources DS (donated supports) = contribution by donators (without corporate donations) – individual donations, International funds and grants, International foundations) Fundraising resources total = total fundraising contributions: contribution by business support and contribution by donators. CHV (cost per hundred visitors) = business contribution for programme activities/ visitors of programme activities supported by business sector Costs per visitor indicate attractiveness and competitiveness of institution programmes for business sector. General business rule is low cost of programme and huge number of visitors. This indicator should be compare with main competitor in cultural sector or with average cultural sector. COMMENT: a. Explain main trends in fundraising income ratio; b. Explain structure of sponsors/donators and their contributions or donators

and their contributions; c. Listed and explain main sponsors/donors as well as their sponsor/donor

strategies. d. Influence of sponsors/donators on programme policy of cultural organization e. Explain number and average sponsorship contributions (donated

contributions); f. Explain main elements of policy for attracting sponsors/business sector g. Recommended some solutions for attracting business sector/improving

fundraising practices etc…. h. Are the programmes competitive from the sponsor point of view i. Explain cost per visitors and costs per hundred visitors as well as main

trends in their value FUNDRISING MARKET INCOME PER AUDIENCE =

audienceofnumber

resourcesgfundraisin

This ration should be compare with the same indication on the expenses side, to identify balance or misbalance between cost growth and fundraising growth. EXPENCES RATIO per audience= running expenses + personal expenses Number of audience

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COMMENT: After calculating you should explain reason for low/high level of ratios; make comparison with other cultural organizations *use data of other student in the group or form different researches). Explain balance or misbalance between cost growth and fundraising growth. What should be done in the future to solve problems in the relation fundraising market income per audience and expenses ratio per audience?

SIMPLE EXAMPLE: cost per visitor (2005) 60 000 euros/ 500 visitors = 120 euros per visitor cost per visitor (2006) 55 000 euros/ 400 visitors = 138 euros per visitor SIMPLE EXAMPLE: (2005)Fundraising resources by business sector – 50 000 euros; total income 2 000 000 euros Fundraising income ratio BS (2005)= (60 000/2 000 000) x 100% = 3% Fundraising income ratio DC (2005)= (30 000/2 000 000) x 100% = 1,5 % Fundraising income ratio BS (2006)= (55 000/1 597 125) x 100% = 3,44% Fundraising income ratio DC (2006)= (15 000/1 597 125) x 100% = 0,94%

7. NET PROFIT RATIO is most often use to measures management’s effectiveness in achieving profitability

NET PROFIT RATIO = Net profit / total income God way to compare net profit ratio is by comparing current ratio with previous one (if you have financial data for a few years) or by comparing current ratio with average profitability ratio for cultural sector (theatres, museums, archive, gallery, visual arts etc) 8. GROSS MARGIN. It helps assess overall profitability of the enterprise. High margins mean more cash moving through the enterprise, thus better overall liquidity, which for small organization is especially important. Lower gross margin than the sector average may indicate the enterprise is going for a “low-price/high volume” strategy. In addition to being relevant to the individual organization, gross margin is important as a measure of the sector’s ability to weather price fluctuations and downturns in the market. Organizations assessing entry into new activities should include gross margin analysis in their review of the market since higher gross margins mean greater operating cushions and, thus, potentially greater ability to use those euros to support program costs of cultural organization.

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GROSS MARGIN = sales income – expenses Sales income

Sales income= income from sold ticket VS. programme expenses Sales income = income from sold goods (book, publication etc) VS. cost of products (production cost, material cost etc) 9. SUBSIDY RATIO: This ratio is a total organization ratio and measures the percentage of the total organization which is subsidized relative to the amount of revenue it generates through sales. While the goal of some non-profit enterprises is to be totally self-sufficient, the goal of others is simply to diversify their revenue base. The lower the percentage, the more fully independent a given non-profit organization is in covering all its costs (both business and programme of operations.

SUBSIDY RATIO = subsidy income Total income

Comment: Compare current ratio with previous one (if you have financial data for a few years) or by comparing current ratio with average for cultural sector (theatres, museums, archive, gallery, visual arts etc)

FINANCIAL SUSTINABILITY

Evaluation of financial sustainability can be made throughout three indicators: Efficiency Index, Self-Sustainability Index (I level) and Self-Sustainability Index (II level). Therefore, the financial sustainability will be exploring by three key dimensions:

Efficiency Index – indicates about financial vitality;

Efficiency Index = revenue/costs

Optimal value 1

Self-Sustainability Index (I level) - measuring changes, progress and identifying trend lines in financial performances;

Self-Sustainability Index I = market resources/costs

Compare result with the average self-sustainability index I of other cultural institutions or organizations with the same programme activities or in the same cultural field (e.g. museums, theatres, gallery etc.).

Comment: Better or worst then average self-sustainability index

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Self-Sustainability Index (II level) – indicates about operative financial performances.

Self-Sustainability Index II = market resources/running and programme expenses Compare result with the average self-sustainability index II of other cultural institutions or organizations with the same programme activities or in the same cultural field (e.g. museums, theatres, gallery etc.).

Financial Feasibility Analysis Matrix

Financial Feasibility Analysis Matrix indicates the main strengths, weaknesses, opportunities and threats which directly or indirectly could exert influence on financial sustainability as well as financial performances of programme implementation or realization of programme activities of cultural organization.

The method is similar as usual SWOT analysis.

EXAMPLE: Financial Feasibility Analysis Matrix

Central Institute for Conservation

Strengths Weaknesses Cost-effective system Adequate space available for services

expansion as well as renting Growth of own resources Effective running expenses

management Available budgetary subsidies Diversification of financial resources Good cash flow management Good research capability for regional

services expansion Support from international

organisations Access to additional funding sources Transfer of tehnical and

management know-how Training and skill development

Overestimating the growth of

fundraising resources Enlargement of functions which can

not be properly dealt with by the Institute

Long time for establishment full capacity of the Institute

Large investment costs Unexpected costs

Opportunities Threats Locally available manpower No single strong competitors on

national or regional level Development of cultural tourism International stakeholders

Economic recession Political crisis Inflation Future revision of budgetary policy Regulatory/public opinion risks

- Describe main findings of Financial Feasibility Analysis Matrix and give some

recommendations

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4. Break Even Analysis

One of the most common tools used in evaluating the economic feasibility of cultural institutions/organization activities, programme activities or cultural product is the break-even analysis. The break-even point is the point at which revenue is exactly equal to costs. The break-even analysis uses information from the income statement and expenses statement to compute how much sales or revenue much be accomplished in order to pay for all of your fixed and variable expenses. At this point, no profit is made and no losses are incurred. The break-even point can be expressed in terms of unit (tickets, users, number of product) or monetary value. That is, the break-even units indicate the level of sales that are required to cover costs. Income above the break-even point results in profit and sales below that number result in a loss. Total variable and fixed costs are compared with sales revenue in order to determine the level of sales volume, sales value or production at which the business makes neither a profit nor a loss (the "break-even point"). First step: All expenses from expenses statement have to be grouping in two categories: Fixed expenses are expenses necessary for running cultural organization. Those expenses do not vary as production/programme activities increases or decreases (e.g. rent, administration costs, insurance, maintenance, etc.). Fixed costs are those business costs that are not directly related to the level of production or output. In other words, even if the business has a zero output or high output, the level of fixed costs will remain broadly the same. In the long term fixed costs can alter - perhaps as a result of investment in production capacity (e.g. adding a new space for cultural programme or administration) or through the growth in running expenses required to support a larger, more complex business. Variable expenses are incurred according to the level of sales of products or services or programme activities. Variable costs are those costs which vary directly with the level of output. They represent payment output-related inputs such as different kind of programme expenses, marketing expenses related to programme activities, honoraries related with programme realization.

A distinction is often made between "Direct" variable costs and "Indirect" variable costs.

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Direct variable costs are those which can be directly attributable to the production of a particular product or service and allocated to a particular cost centre. Production expenses and the wages are good examples of direct variable costs.

Indirect variable costs cannot be directly attributable to production but they do vary with output. These costs include maintenance expenses and certain labour costs.

Semi-Variable Costs

Whilst the distinction between fixed and variable costs is a convenient way of categorising business costs, in reality there are some costs which are fixed in nature but which increase when output reaches certain levels. These are largely related to the overall "scale" and/or complexity of the business. For example, when a business has relatively low levels of output or sales, it may not require costs associated with functions such as security department or a finance department. However, as the scale of the business grows (e.g. output, number programme activities, number and complexity of transactions) then more resources are required. In these circumstances, we say that part of the cost is variable and part fixed.

Break-Even Analysis is a tool to calculate at which revenue volume the variable and fixed costs of programme activities will be covered. Another way to look at it is that the break-even point is the point at which planned programme activities stops costing cultural organization money to produce, and starts to generate a profit for your company. Break-even analysis can help you when deciding how much to charge for a service, how much to ask for from donors, to identify financial risks etc. There are three tapes of break even point: 1. Break even point (value) BREAK EVEN POINT = (Fixed expenses / (% operational profit) x 100 Break even point (income value) is use to evaluate financial feasibility of institution in risky circumstances, overall capacity to solve financial risk etc. Margin of safety is additional instrument in the Break-even analysis which shows how much output or sales level can fall before a business reaches its break-even point.

Margin of safety = (income – break-even point / income) x 100%

2. Break even point (units)

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BREAK EVEN POINT = (Fixed expenses / (price per unit – variable costs per unit) x 100 Break even point (units) is use to identify number of units (visitors, tickets etc) which is necessary for covering all expenses of programme activities. 3. Break even point (price) BREAK EVEN POINT (price) = (Price per unit/ (total revenues / total expenses) Break even point (units) is use to identify how much to charge for a service, ticket, product etc. EXAMPLE: BREAK EVEN POINT (income value) In 2009, The Museum of contemporary art planes to realize income of 48 000 euros. Programme activities related to this income are: exhibition 1 (programme expenses 4000 euros & programme income 4.500 euros), exhibition 2 (programme expenses 2 euros & programme income 5000 euros), exhibition 3 (programme expenses 4000 euros & programme income 5000 euros) and exhibition 4. (programme expenses 3000 euros & programme income 5000 euros). The Museum of contemporary art will receive for running and regularly activities (restoration, library, workshops, educational lecturers, publishing etc) budget subsidies by the Ministry of culture (28 500 euros). Due to financial crises Government introduce restrictive budgetary policy. For the same reasons, business sector as well as donors reduces budgets for supporting cultural activities. The Museum of contemporary art wants to evaluate financial feasibility as well as potential financial risks of institution under those new circumstances (financial crisis). Expenses statement of The Museum of contemporary art

1. Direct programme salaries/labour expenses for programme 1-4 10.000,00 2. Direct material / services expenses for programme 1-4 5.000,00 3. Other variable expenses related to programme activities 1.000,00 Total variable costs (1+2+3) 16.000,00 4. Salaries 15.000,00 5. Rent 5.000,00 6. Utilities (electricity, phone, internet, etc) 3.500,00 7. Insurance 1.000,00 8. Taxes (property tax, other taxes) 500,00 9. Marketing expenses 1.500,00 10. Travel expenses 2.000,00 11. Other expenses 1.000,00 Total Fixed costs (7……11) 29.500,00 Total costs 45.500,00

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ELEMENTS FOR CALCULATIN BREK EVEN POINT 1. Total revenues 48.000,00 2. Variable costs 16.000,00 Operational income (1-2) 32.000,00 Fixed costs 29.500,00 % variable costs 33,33% % operational income 66,67% % variable costs = (variable costs / total income) x 100% % operational profit = (operational profit / total income) x 100% BREAK EVEN POINT (value) = (Fixed expenses / (% operational profit) x 100 Break even point = (29 500 / 66,67%)x 100 = 44 250 euros % of income Total revenue Fixed costs Variable costs Total costs 0,00% 0,00 29.500,00 0,00 29.500,00 25,00% 12.000,00 29.500,00 4.000,00 33.500,00 50,00% 24.000,00 29.500,00 8.000,00 37.500,00 92,19% 44.250,00 29.500,00 14.750,00 44.250,00 100,00% 48.000,00 29.500,00 16.000,00 45.500,00

EXAMPLE:

Margin of safety = (48 000 – 44 250/ 42 500) x 100% = 8%

Comments: Income resources of 44 250 euros are necessary for covering all variable and fixed costs of planed activities. In income statements total income is 48 000 euros which indicate that total income can be reduce up to 8% without any risk on realization of planned activities. There is high financial risk, because the margin of safety is very low. The museum of contemporary art can not realize regularly activities with budget subsidies, so the Museum have to realize minimum 2 programme activates which will provide additional revenues (for business sector and donors) for covering total expenses of the Museum or to reduce regularly and programme activities.

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EXAMPLE: Break even units The Museum of contemporary art planes to realize 2 project activities which should be financing by ticket revenues as well as participation fees. 1st project activity (exhibition) has total cost 10 000 euros and 2nd project activity (educational seminar) has total cost 12 000 euros. Cost structure (project 1): variable costs 8 000 euros, fixed cost 2 000 euros Cost structure (project 2): variable costs 6 000 euros, fixed cost 6 000 euros The estimate of the Museum is that project 1 will earn 12 000 euros from ticket sale) while project 2 will earn 13 000 euros from participation fees. Variable costs 1 project 8.000,00 Variable costs 2 project 6.000,00 Variable costs 14.000,00 Fixed costs 1 project 2.000,00 Fixed costs 2 project 6.000,00 Fixed costs 8.000,00 Total costs 22.000,00 ELEMENTS FOR CALCULATIN BREK EVEN POINT Total revenues 25.000,00 Variable costs 14.000,00 Operational income 11.000,00 Fixed costs 8.000,00 Gross Profit 3.000,00 % variable costs 56,00% % operational income 44,00% Break even point (value) = 18 182 euros Margin of safety = 27,3% Income resources of 18 182 euros are necessary for covering all variable and fixed costs of both project activities. In income statements total planned income is 22 000 euros which indicate that total income can be reduce up to 27,3% without any risk on realization of planned activities. PROJECT 1: 12000 euros will be earn by selling 2 400 tickets (price per ticket is 5 euros). The Museum of contemporary art to identify two thinks: how much the ticket price can be reduce without any financial risk related to realization project activities and how many visitors are necessary for covering project expenses.

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Variable costs 1 project 8.000,00 Fixed costs 1 project 2.000,00 Total costs 10.000,00 ELEMENTS FOR CALCULATIN BREK EVEN POINT Total revenues 12.000,00 Variable costs 8.000,00 Operational income 4.000,00 Fixed costs 2.000,00 Gross Profit 2.000,00 % variable costs 66,67% % operational income 33,33% BREAK EVEN POINT (units) = Break even capacity income x total units (See excel workbook) 1200 visitors BREAK EVEN POINT (price) = (Price per unit/ (total revenues / total expenses) Minimal price is 4,16 euros