Transcript Chapter 6 - Business Costs & Revenue

Chapter 6 –
Business Costs & Revenue
Syllabus Unit – Business Finance and Accounting
You will learn ……
Why businesses need to know the costs
of running their activities and the revenue
gained by selling their products
 The different types of costs involved in
running a business
 How break-even analysis helps managers
make decisions
 The purpose of budgets and financial
forecasts

Business Costs

Why do we need to
know business
costs?
◦ Comparing Costs &
Revenue
◦ Determining
Profit/Loss
◦ Comparing locations of
a possible new site
◦ Price Determination
Business Costs
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List 10 costs that would be involved in
opening and running a new factory
making sport shoes
Business Costs

Fixed Costs (FC)
◦ Do not vary with
output in the shortterm
◦ Paid regardless of
output
◦ “Overhead Costs”
Business Costs

Variable Costs (VC)
◦ Vary with output
◦ Costs directly associated
with output
◦ “Direct Costs
Business Costs

Total Costs (TC)
◦ Fixed Costs
+
Variable Costs
Break-Even
The Break-even point (BEP) is the
point at which cost or expenses and
revenue are equal: there is no net loss or
gain
 Break-even charts show;

◦ Costs
◦ Revenue
 Price x Quantity (P x Q)
◦ Level of sales to breakeven
Break-even
Break-Even Charts
Break-even Charts
Namib Tyres Ltd produce
motorcycle tyres. The
following information about
the business has been
obtained
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Fixed Costs are $30,000 per year
Variable Costs are $5 per unit
Each tyre is sold for $10
Maximum output is 10,000 tyres
per year
Break-even Charts

Advantages
◦ Identify break-even point of
production
◦ Calculate maximum profit
◦ Expected profit/loss at
different levels of output
◦ Impacts on BEP with various
business decisions
◦ Helps in decision-making
◦ Margin of Safety
Break-even Charts

Disadvantages
◦ Assumes all goods
produced are sold
◦ Fixed costs constant only
if scale of production
doesn’t change
◦ Ignores other aspects of
the business which need
to be analysed
◦ Straight lines not realistic
Break-Even Equation

Breakeven Equation
Total Fixed Costs
Contribution Per Unit

Contribution
◦ Selling Price – Variable Cost
Break-Even Equation
A fast food restaurant sells meals for $6
each. The variable costs of preparing and
serving each meal are $2. The monthly fixed
costs amount to $3600
a) How many meals must be sold each month
for the restaurant to break-even?
b) If the restaurant sold 1500 meals in one
month, what was the profit made in that
month?
c) If the cost of the food ingredients rose by
$1 per meal, What would be the new
break-even level of production?

More Business Costs

Direct Costs
◦ Directly identified with each unit of
production
◦ Vary with the level of output
More Business Costs

Indirect Costs
◦ Not identified with each unit of production
◦ Associated with performing a range of tasks
or producing a range of products
◦ Overheads
More Business Costs

Marginal Costs
◦ Additional costs for producing one more unit
of product
◦ Extra variable costs will be needed for that
one extra unit
More Business Costs

Average Cost Per Unit
Total Costs
Output
Economies of Scale

Purchasing Economies
◦ Bulk-buying discounts
Economies of Scale

Marketing Economies
◦ Transport
◦ Advertising
Economies of Scale

Financial Economies
◦ Lower interest rates
Economies of Scale
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Managerial Economies
◦ Specialists in all departments
Economies of Scale

Technical Economies
◦ Specialisation
◦ Latest equipment
Diseconomies of Scale

Poor Communication
Diseconomies of Scale

Slower Decision-Making
Diseconomies of Scale

Low Moral
Budgets & Forecasts

Budgets
◦ Plans for the future
containing numerical or
financial targets

Forecasts
◦ Are predictions of the
future
Reasons why businesses fail

Do not consider
future at all and make
no plans

Unprepared for
unforeseen events
Budgets & Forecasts

Managers try to
predict/forecast
◦ Sales / Customer
Demand
◦ Exchange rates of the
currency
◦ Wage rises
Budgets & Forecasts

A managers biggest problem is …….
uncertainty about the future
Forecasting Methods

Trend
◦ An underlying movement or direction of data
overtime
◦ This can be extended into the future
Forecasting Methods

Line of Best Fit
◦ Figures plotted on graph (scatter diagram)
◦ Line extended into the future
Forecasting Methods

Panel Consensus
◦ A panel of experts are asked for their
opinions
◦ Most likely to be on future sales
Forecasting Methods

Market Research Surveys
◦ Useful in forecasting sales that are yet to be
launched onto the market
◦ No previous data exists
Budgets

Plans for the future containing numerical
and financial targets
Budgets
Businesses plan months/years ahead
 Plan ahead for future reactions
 Future targets in numerical/financial terms

Budgets
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Budgets are set for;
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Revenues
Costs
Production Levels
Raw Material Requirements
Labour Hours Needed
Cash Flow
Master budget is derived
from these smaller
budgets
Budget and Forecasts
Budgets
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Advantages
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Departmental Target Setting
Gives focus
Motivates
Variance Analysis
Worker, Supervisor & Manager involvement
Helps to control the business
Budgets
Reviewing past activities
Budgeting useful for:
Comparing actual with
budgeted figures
Controlling current
business activity –
Keeping to Targets
Planning for the Future
Setting Goals to be
achieved