Download Cost, revenue, profit Fixed costs

IB BUSINESS
MANAGEMENT
Unit 3/Section 3.2
Costs and Revenues
3.2 COSTS AND REVENUES
ON COMPLETING THIS CHAPTER YOU SHOULD BE ABLE TO
 Explain the different types of costs, using examples.
 Comment on the meaning of the term revenue and, using
examples, suggest various revenue streams available to
organizations.
COST, REVENUE, PROFIT
1.
Cost refers to the total expenditure incurred by a business in
order to run its operations.
2. Revenue is a measure of the money generated from the sale of
goods and services.
3. Profit is calculated by finding our the difference between
revenues and costs.
TYPES OF COSTS
 Fixed costs do not change with the amount of goods or services produced.
Related to time
Examples: Monthly rent, insurance and salaries
 Variable costs change with the amount of goods or services produced.
Related to activity
Examples: Raw materials, sales commissions, packaging and wages
TC ( Total Costs) = TFC ( Total Fixed Costs) + TVC ( Total Variable Costs)
TYPES OF COSTS
 Direct costs can be identified with the production of specific goods or services.
Examples: Cost of raw materials, labor, packaging, electricity to run machines
 Indirect costs are shared and cannot be easily identified with the production of
specific goods or services.
Examples: Rent, office worker salaries, legal expenses, advertising, insurance
Notes:
Fixed cost category is similar to Indirect, and variable cost is similar to Direct.
Semi-variable costs remain fixed for a given level of production, after which
they become variable.
Example: Overtime made for working extra hours
Which would you choose?
Fixed/Variable Costs
 Rent
 Cost of materials used in making a washing
machine
 Electricity used to cook fast food
 Fixed
 Variable
 Variable
Which would you choose?
Direct/Indirect Costs
 A hamburger in a fast food restaurant: the cost
of the meat
 A farm: the purchase of a tractor
 Servicing a car in a garage: the labor cost of the
mechanic
 A supermarket: promotional expenditure
 The business studies department: the salary of
the business studies teacher
 Direct
 Indirect
 Direct
 Indirect
 Direct
TOTAL REVENUE
Total Revenue is the total amount of money a firm receives from its sales.
Total Revenue = price per unit x quantity sold
TR = P x Q
Example: If a toy-producing firm charges $8 per toy and sells 200.000
toys a month, then its total revenue for the month will be ($8 x 200.000)
$1.600.000.
REVENUE “STREAMS”
 A firm’s revenue is obtained not only from its trading activities.
 Examples of other revenue streams:
 Rental income - renting part of a factory to another firm
 Sale of fixed assets - selling old buildings or machinery
 Dividends - firms have investments in other companies
 Interest on deposits
 Donations
 Grants and subsidies from government
IB BUSINESS
MANAGEMENT
Unit 3/Section 3.3
Break-even analysis
3.3 BREAK-EVEN ANALYSIS
ON COMPLETING THIS CHAPTER YOU SHOULD BE ABLE TO
 Distinguish between contribution per unit and total contribution.
 Draw a break-even chart and calculate the break-even quantity
profit and margin of safety.
 Calculate target profit output, target profit and target price.
 Analyse the effects of changes in price or cost on break-even
quantity profit and margin of safety, using graphical and
quantitative methods.
 Examine the benefits and limitations of break-even analysis.
CONTRIBUTION
Can be used in calculating how many products need to be sold in
order to cover a firm’s costs.
1. Contribution per unit = price per unit – variable cost per unit
2. Total contribution = total revenue – total variable cost
3. Total contribution = contribution per unit x number of units
sold
4. Profit = total contribution – total fixed assets
IN CLASS – EXERCISE
OXFORD PG 180
BREAK-EVEN POINT
Where the total costs equal the total revenue. At this point a
business will neither make a profit nor a loss.
BREAK-EVEN CHART
Graphical method that measures the value of a firm’s costs and
revenues against a given level of output sales or units of
production.
Follow my simple instructions,
and you’ll be alright
Money
Label the x axis
output i.e.
sales/units, and the
y axis cost or
revenue, i.e. $
money
OUTPUT
Money
Fixed cost (FC) is
always a horizontal line
because it doesn’t
change as output
increases
Fixed
Costs
OUTPUT
Money
With no units of
output there will
be no variable costs
(VC). The higher
the units produced
the higher the
variable costs
Variable
costs
Fixed
costs
1000
OUTPUT
Money
Draw a line parallel
to the variable cost
line, that starts
where the FC line
does
Total costs
Variable
costs
Fixed
costs
OUTPUT
With no output
sold there will not
be revenue.
Therefore the
Total Revenue line
begins from the
origin (zero)
Money
Total Revenue
Total
costs
Variable
costs
Fixed
costs
1000
OUTPUT
Where the
revenue and
total cost lines
cross is the
break even
point
Money
Total Revenue
Break even point
Total
costs
Variable
costs
Fixed
costs
Break even quantity 1000
OUTPUT
PROFIT
The positive difference between total revenue and total costs.
The left of the
break-even
point shows the
loss, whereas
the right of this
point shows the
profit
Money
Total Revenue
Break even point
Profit
Total
costs
Loss
Variable
costs
Fixed
costs
Break even quantity 1000
OUTPUT
Profit per unit is Money
the VERTICAL
distance between
the Total Revenue
and TC lines
Total Revenue
profit
Total Costs
Variable Costs
Fixed Costs
OUTPUT
MARGIN OF SAFETY
A measure of the difference between the break-even level of
output and the actual (current) level of output.
The greater the difference between the break-even quantity and
the sales levels, the greater the safety net or the safer a firm will
be in its profit earnings.
Margin of safety = current output – break-even output
Money
Total Revenue
Margin of safety is
the difference
between current
output, and the
break- even point
Total
costs
Variable
costs
Fixed
costs
Margin
of safety
Breakeven
point
Current
OUTPUT
output
IN CLASS
–
EXERCISE
OXFORD PG 182
CALCULATING BREAK-EVEN
QUANTITY
1. Using contribution per unit
Break-even quantity = fixed costs/ contribution per unit
2. Using total costs= total revenue method
Total Revenue ( TR) = Total Costs (TC)
P x Q = TFC + TVC
PROFIT OR LOSS
Profit = Total Revenue (TR) – Total Costs (TC)
Profit = (P x Q) - (TFC + TVC)
TARGET PROFIT OUTPUT
The level of output that is needed to earn a specified amount
of profit.
Target profit output = fixed costs + target profit
contribution per unit
Target profit output = fixed costs + target profit
(target price per unit – variable cost per unit)
BREAK-EVEN REVENUE
It is the revenue required to cover both the fixed and
variable costs in order for a firm to break even. At this
point the break-even revenue is equal to the break-even
costs.
Break-even Revenue =
fixed costs
contribution per unit
x
price per unit
IN CLASS
–
EXERCISE
OXFORD PG 186
EFFECTS OF CHANGES
IN PRICE OR COSTS
IN CLASS
–
EXERCISE
OXFORD PG 188
IN CLASS
–
EXERCISE
OXFORD PG 188
BENEFITS AND LIMITATIONS OF
THE BREAK-EVEN ANALYSIS
Benefits:
 Easy visual analysis
 At a glance
 Formulae friendly
 Easy to compare changes
 Strategic decision-making tool
Limitations:
 Assumes all output produced is sold, with no
stock
 Assumes all revenue and cost lines are linear
no discounts
 No semi-variable costs
 Relies on accuracy and quality of data
IN CLASS
–
EXERCISE
OXFORD PG 190