Calculating Costs, Revenues and Profit
Today’s session
Identification of fundamental business cost elements
Distinguishing between revenue and profit
Calculating costs and revenue at different levels of output
Calculating profit or loss
Calculating costsWhy businesses need accurate and reliable cost information
Defining Costs
QUESTION – WHY do businesses need to define potential COSTS?
ANSWER – to enable them to make informed business decisions in order to remain profitable
Identifies likely BUSINESS VIABILITY e.g enables the business to forecast actual profit or loss that will be made
Allows the business to make PRICING DECISIONS
A PROFIT SURPLUS can provide a source of finance for further expansion
ACTIVITY – using the whiteboard, list as many costs as you can think
of for a new business – we will come back to these costs later...
Opportunity Cost
What is the definition of OPPORTUNITY COST – write the
answer on your whiteboard
Opportunity Cost = the cost of the next best alternative
forgone.The value that could have been earned if a resource
was employed in its next best use. e.g. if spend £40k on advertising campaign it could have been
earning interest in a bank account.
Accounting Costs
Accounting costs are recorded in the business accounts as an ASSET or as an EXPENSE
Accounting Cost = the value of an economic resource used up in
production
Jot down an example of an ASSET and an EXPENSE in your notes
Changing costs – Short and Long Run
Costs can change over a period of time as a business grows and develops
SHORT RUN
At least one factor of production is fixed e.g. Amount of space, available machinery
LONG RUN
All factors may vary. Capacity may be increased but when saturation is reached another SHORT RUN period will begin.
Types of Cost Costs can be
FIXED
The same at all levels of output in the short run
VARIABLE
Costs of production that increase directly as output rises
SEMI-VARIABLE
Costs that consist of a fixed value + a variant value which can increase dependent on usage
TOTAL COSTS are all the fixed and variable costs added together
– TC = FC + VC
Jot down an example of a FIXED COST, a VARIABLE COSTS and a SEMI-VARIABLE COST in
your notes. Compare your list.
Fixed Costs
Diagram shows that even as output increases fixed costs stay the same. It’s a short run scenario usually.
Stepped Fixed Costs
This can occur over a longer period of time following for example an investment in new machinery.
Variable Costs
Diagram shows that as output increases the variable costs increase.
Total Costs
As output increases fixed costs become smaller part of total costs
ACTIVITY – 3 minutes
Fixed costs £000 Variable costs £000
TOTAL COSTS £000
100 140
750 1000
364 640
Calculate the fixed, variable and total costs for trading at Sycks Buckets
How did you do...
Fixed costs £000 Variable costs £000
TOTAL COSTS £000
100 40 140
250 750 1000
364 640 1004
Calculate the fixed, variable and total costs for trading at Sycks Buckets
Activity
Using the list on the board and working in pairs, identify which costs are FIXED, VARIABLE and SEMI-VARIABLE
Compare your answers to the next pair – do they match?
More on costs...
Costs can be
DIRECT
identified to a specific product
Usually VARIABLE
INDIRECT
accrued across the business
Usually FIXED
Also known as OVERHEADS
Identify which are DIRECT and which are INDIRECT costs at Sycks Buckets
Rent Bucket moulds
Catering Telephone
Factory heating
Business loan
Packaging
Bucket handles
Bucket rivets
Production
labour
Accounts staff
Bucket sales team
How did you do?
Rent Bucket moulds
Catering Telephone
Factory heating
Business loan
Packaging
Bucket handles
Bucket rivets
Production
labour
Accounts staff
Bucket sales team
KEY:-DIRECTINDIRECT
Activity
Using the list on the board and working in pairs, identify which costs are DIRECT and INDIRECT
Compare your answers to the next pair – do they match?
Yet more on costs..
AVERAGE COST (UNIT COST)
Cost per unit of production
Calculation:-
Average cost = Total costOutput
QUESTION – What does the TOTAL COST figure consist of?
ANSWER – FIXED COSTS + VARIABLE COSTS
AC= FC + VCOutput
You can also calculate average costs for...
AVERAGE FIXED COST
Calculation:-
Average fixed cost = Total fixed costOutput
AFC= FCOutput
£ AVERAGE VARIABLE COST€ Calculation:-
Average variable cost = Total variable costOutput
AVC= VCOutput
Calculate the average costs
Output Fixed Cost
Average fixed cost
Variable Cost
Average
variable cost
Total Cost
Average cost
100 100 150
200 100 300
300 100 450
400 100 600
Average cost calculations
Output Fixed Cost
Average fixed cost
Variable Cost
Average
variable cost
Total Cost
Average cost
100 100 1.00 150 1.50 250 2.50
200 100 .50 300 1.50 400 2.00
300 100 .33 450 1.50 550 1.83
400 100 .25 600 1.50 700 1.75
Marginal cost
Marginal cost is the cost of increasing total output by one more unit
Marginal cost = Change in Total CostChange in Output
MC= CITCCIO
Output Fixed Cost
Variable Cost
Total Cost
Change in
output
Change in total cost
Marginal cost
100 100 150 250 101 252.50 2.50
COSTS Checkpoint – what you can remember??
Working in your teams, match the COSTS to the DEFINITIONS
First group to complete the puzzle wins the prize and gets the points
In the event of a draw, there will be a finance tie-breaker...
Cost classification – the theory... By TYPE, i.e. Analysing business costs to identify if they are
Direct or indirect
By BEHAVIOUR i.e. the effect a change in output levels has on costs
Fixed, variable, semi-variable, average, marginal
By FUNCTION i.e. The business function they are associated with
Production, selling, administration, HR
By the NATURE of the resource i.e. Classifying according to resource acquired
Materials, labour, expenses
By PRODUCT, CUSTOMER or CONTRACT
Cost classification – the reality... Cost classification not always straightforward
Difficulties in options for cost classification dependent on nature of cost e.g.
Piece rate – direct or variable
Administrator salary – fixed or indirect
Challenges of allocating indirect costs to each product
Classification often depends on classification purpose as well as
management viewpoint
Total Revenue
Total revenue is the amount of money received from selling a product
Total Revenue= Quantity Sold x Price
TR= QS x P
Output (000)
Total Revenue
£000
Q- What is the total revenue for 500 products sold at £5 each?
A- 500 x £5 = £2500
Profit and Loss PROFIT is the difference between REVENUE and COSTS
Revenue EXCEEDS Costs = PROFIT
Costs EXCEED Revenue = LOSS
Q - If Sycks Buckets have a monthly revenue of £30,000 for and costs of £26,400 how
much profit have they made?A - £30,000 - £26,400 = £3,600
Q - If costs increase by 15% and revenue remains static, how much profit have they
made now?A - £30,000 - £30,360 = (£360) LOSS
Profit
Profit is a surplus. It is important for 4 reasons:1. Used as a measure of success by the owners of
a business who have invested capital into it.2. Banks/other lenders may be unwilling to lend to
businesses making a loss or not forecasting a profit.
3. It is the return/reward for the entrepreneurs risk taking
4. Can provide a source of finance for the business.
Why calculate costs?
To help forecast profit/loss
To forecast breakeven point
For financial planning
For pricing decisions
To keep check of actual costs against projected ones
Today’s session
Identification of fundamental business cost elements
Distinguishing between revenue and profit
Calculating costs and revenue at different levels of output
Calculating profit or loss
Any Questions??
Next session - contribution
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