Chapter 6 Business Costs & Revenue

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 productsThe different types of costs involved in running a businessHow break-even analysis helps managers make decisionsThe purpose of budgets and financial forecastsBusiness CostsWhy do we need to know business costs?Comparing Costs & RevenueDetermining Profit/LossComparing locations of a possible new sitePrice 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

7Break-EvenThe Break-even point (BEP) is the point at which cost or expenses and revenue are equal: there is no net loss or gainBreak-even charts show;CostsRevenuePrice x Quantity (P x Q)Level of sales to breakeven

Break-even

Break-Even Charts

Break-even ChartsNamib Tyres Ltd produce motorcycle tyres. The following information about the business has been obtainedFixed Costs are $30,000 per yearVariable Costs are $5 per unitEach tyre is sold for $10Maximum output is 10,000 tyres per year

Activity 6.3Draw table on board. Students complete questions11Break-even ChartsAdvantagesIdentify break-even point of productionCalculate maximum profitExpected profit/loss at different levels of outputImpacts on BEP with various business decisionsHelps in decision-makingMargin of Safety

Break-even ChartsDisadvantagesAssumes all goods produced are soldFixed costs constant only if scale of production doesnt changeIgnores other aspects of the business which need to be analysedStraight lines not realistic

Ignores issues such as how to reduce wastage or increase sales 13Break-Even EquationBreakeven EquationTotal Fixed Costs Contribution Per Unit

ContributionSelling Price Variable Cost

14Break-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 $3600How many meals must be sold each month for the restaurant to break-even?If the restaurant sold 1500 meals in one month, what was the profit made in that month?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 CostsDirectly identified with each unit of productionVary with the level of output

More Business CostsIndirect CostsNot identified with each unit of productionAssociated with performing a range of tasks or producing a range of productsOverheads

More Business CostsMarginal CostsAdditional costs for producing one more unit of productExtra variable costs will be needed for that one extra unit

More Business CostsAverage Cost Per UnitTotal Costs Output

Students complete Activity 6.519Economies of ScalePurchasing EconomiesBulk-buying discounts

Economies of ScaleMarketing EconomiesTransportAdvertising

Economies of ScaleFinancial EconomiesLower interest rates

Economies of ScaleManagerial EconomiesSpecialists in all departments

Economies of ScaleTechnical EconomiesSpecialisationLatest equipment

Diseconomies of ScalePoor Communication

Diseconomies of ScaleSlower Decision-Making

Diseconomies of ScaleLow Moral

Budgets & ForecastsBudgetsPlans for the future containing numerical or financial targets

ForecastsAre predictions of the future Reasons why businesses failDo 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 MethodsTrendAn underlying movement or direction of data overtimeThis can be extended into the future

Forecasting MethodsLine of Best FitFigures plotted on graph (scatter diagram)Line extended into the future

Forecasting MethodsPanel ConsensusA panel of experts are asked for their opinions Most likely to be on future sales

Forecasting MethodsMarket Research SurveysUseful in forecasting sales that are yet to be launched onto the marketNo 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;RevenuesCostsProduction LevelsRaw Material RequirementsLabour Hours NeededCash FlowMaster budget is derived from these smaller budgets

Budget and Forecasts

BudgetsAdvantagesDepartmental Target SettingGives focus MotivatesVariance AnalysisWorker, Supervisor & Manager involvementHelps to control the business

Variance Analysis Difference between budgetary figure and actual figureWorker, Supervisor & Manager involvement Motivates & More realistic budgets result More likely to work harder to achieve target if they have their say in setting it 40

BudgetsReviewing past activitiesComparing actual with budgeted figuresBudgeting useful for:Controlling current business activity Keeping to TargetsPlanning for the FutureSetting Goals to be achieved

Students complete Activity 6.6 Page 10241