Chapter 6 – Business Costs & RevenueSyllabus 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 CostsWhy do we need

to know business costs?◦Comparing Costs &

Revenue◦Determining

Profit/Loss◦Comparing

locations of a possible new site

◦Price Determination

Business CostsList 10 costs that would be

involved in opening and running a new factory making sport shoes

Business CostsFixed Costs (FC)

◦Do not vary with output in the short-term

◦Paid regardless of output

◦“Overhead Costs”

Business CostsVariable Costs

(VC)

◦Vary with output

◦Costs directly associated with output

◦“Direct Costs

Business CostsTotal Costs (TC)

◦Fixed Costs +

Variable Costs

Break-EvenThe 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◦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 ChartsAdvantages

◦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 ChartsDisadvantages

◦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 EquationBreakeven Equation

Total Fixed Costs Contribution Per Unit

Contribution◦Selling Price – Variable Cost

Break-Even EquationA 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 CostsDirect Costs

◦Directly identified with each unit of production

◦Vary with the level of output

More Business CostsIndirect Costs

◦Not identified with each unit of production

◦Associated with performing a range of tasks or producing a range of products

◦Overheads

More Business CostsMarginal Costs

◦Additional costs for producing one more unit of product

◦Extra variable costs will be needed for that one extra unit

More Business CostsAverage Cost Per Unit

Total Costs Output

Economies of ScalePurchasing Economies

◦Bulk-buying discounts

Economies of ScaleMarketing Economies

◦Transport◦Advertising

Economies of ScaleFinancial Economies

◦Lower interest rates

Economies of ScaleManagerial Economies

◦Specialists in all departments

Economies of ScaleTechnical Economies

◦Specialisation◦Latest equipment

Diseconomies of ScalePoor Communication

Diseconomies of ScaleSlower Decision-Making

Diseconomies of ScaleLow Moral

Budgets & ForecastsBudgets

◦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 & ForecastsManagers try to

predict/forecast

◦Sales / Customer Demand

◦Exchange rates of the currency

◦Wage rises

Budgets & ForecastsA managers biggest problem is

…….uncertainty about the future

Forecasting MethodsTrend

◦An underlying movement or direction of data overtime

◦This can be extended into the future

Forecasting MethodsLine of Best Fit

◦Figures plotted on graph (scatter diagram)

◦Line extended into the future

Forecasting MethodsPanel Consensus

◦A panel of experts are asked for their opinions

◦Most likely to be on future sales

Forecasting MethodsMarket Research Surveys

◦Useful in forecasting sales that are yet to be launched onto the market

◦No previous data exists

BudgetsPlans for the future containing

numerical and financial targets

BudgetsBusinesses plan months/years

aheadPlan ahead for future reactionsFuture targets in

numerical/financial terms

BudgetsBudgets are set for;

◦Revenues◦Costs◦Production Levels◦Raw Material

Requirements◦Labour Hours Needed◦Cash Flow

Master budget is derived from these smaller budgets

Budget and Forecasts

BudgetsAdvantages

◦Departmental Target Setting◦Gives focus ◦Motivates◦Variance Analysis◦Worker, Supervisor & Manager

involvement◦Helps to control the business

Budgets

Reviewing past activities

Comparing actual with budgeted

figures

Budgeting useful for:

Controlling current business activity –Keeping to Targets

Planning for the Future

Setting Goals to be achieved