Component 1- Business revenue and costs
Costs, revenue and profit
Break- even
break even chart
usefulness of break-even to a business and its stakeholders
Revenue= money business makes from sales- value of the sales; referred to as turnover;
total amount of money a business receives from its sales is called total revenue;
Total Revenue = Quantity of Units Sold x Selling Price
by finding total revenue business can work out if they have made a profit or a loss
Profit = Total Revenue – Total Costs
Fixed costs= costs that don't vary with output; no matter how much is made/ how little is sold, fixed costs have to be paid- rent/ mortgage, business rates, electricity
Variable costs are different from fixed costs in that they vary in direct proportion to output – as output increases, variable costs increase; as output falls, variable costs fall
once output is underway, raw materials start being used
at output zero, variable costs are zero, though at output zero, fixed costs still have to be paid, but as output increases, variable costs also rise
often assumed there is constant relationship between output- variable costs, but in most cases this constant relationship does not hold true. Businesses more often benefit from purchasing economies of scale, so as output increases, variable costs per unit produced start to fall
Not all costs can be defined as fixed or variable. Some costs such as labour could be fixed- a permanent member of staff working a 38-hour week or variable- the member of staff being asked to work 5 hours overtime due to increased demand-> called semi-variable
Direct costs are costs that arise specifically from the production of a product or the provision of a service.
materials or components; direct labour; some expenses, e.g. copyright payments on a published book or license fees for use of patents
Totaling the above will provide you with direct costs of producing the product. However, subtracting direct costs from revenue does not indicate profitability; business must also apportion overheads/ indirect costs to the product; production of any product results in a business paying costs not directly related to production or service provision
true profitability of a product, factory, outlet, etc. can only be judged if you subtract both direct costs and overheads from the revenue-> overheads are costs not directly related to production.
A business will always want to know how many products they need to sell in order to cover costs- normally bare minimum a business will aim to achieve
business is breaking even, there is no profit and no loss-> revenue = total costs
Once costs in a business are worked out, next step in calculating break-even output/ sales is finding out how much return/ contribution a business makes from each individual item that it sells
Every product made has variable cost + selling price; difference between selling price per unit +variable cost per unit is known as the contribution towards covering the business’s fixed costs
Break-even Output = Fixed Costs divided by Contribution Per Unit
allows us to calculate the profit or loss a business will make at different levels of output
The vertical axis (y) shows the level of costs and revenue- draw a vertical axis, ensuring that its range goes from £0 to at least the largest number
horizontal axis (x) shows the level of output and sales
plot next lines:
Fixed costs- don't change with level of output;
Total costs;
Revenue;
point where revenue line cuts total costs line= break-even point
horizontal line drawn from break-even point to costs/revenue axis will give you break-even costs/revenue
To find profit/ loss at different outputs, we must measure difference between revenue line +total costs line at given level of output
If the given output is to right of break-even point, a profit will be made. If given output is to left of break-even point, a loss will be made
margin of safety in a business is difference between output level- when output is above break-even + break-even output
margin of safety indicates amount by which demand can fall before business incurs losses- margin of safety can be identified on break-even chart by measuring difference between break-even point +level of output
need to ensure they have a healthy margin of safety just in case an unexpected drop in sales affects business- small margin of safety could put business at risk
costs and revenues- not fixed; break-even chart can be used to show effect of an increase/ drop in revenue + costs on profitability of a business
increase in price will change the total revenue line- will become steeper and will cut the total cost line sooner, resulting in break-even at a lower level of output
if price reduced, the opposite would happen, and break-even point would be at a higher level of output
increase in variable costs will change total cost line- becomes slightly steeper + will cut revenue line at higher output level-> break-even at higher level of output. If costs reduced, opposite would happen
if variable costs remained same but fixed costs changed, outcome would be a parallel shift in total cost line
provides a simple and easily understood representation of costs, revenue and potential profit
useful as part of a business plan and can help when seeking a loan
allows the use of ‘what-if’ analysis. Using ‘what-if’ analysis, business owners can judge the impact of a number of costs and revenue variables on profitability
impact of the changes on break-even output, margin of safety and profitability can be measured
doesn't fully overcome weaknesses of break-even- method assumes only one product is produced and sold; in real world of business-rarely the case-> initial problem can be overcome if a business sells a similar range of products as, in this case, an average cost and revenue per customer can be estimated
linear relationship of costs/revenue to output/sales can also be questioned. In each case, economies of scale are likely to come into play, breaking down the relationship
assumes all goods are produced +sold at same price; most businesses have wastage through damaged stock, poor quality stock, etc. likely that at least some products- end of line, will be discounted
some fixed costs are stepped- occurs when business acquires more capacity, whereby costs such as rent may increase-> sharp rise in fixed costs makes it difficult to apply break-even analysis