1.3.2 Business Revenues, Costs and Profits Flashcards
Revenue (sales revenue, sales turnover):
amount of income received from selling goods or services over a period of time
How do you calculate revenue?
revenue = price x quantity sold
Costs:
what the business pays to provide the good or service
Variable costs:
costs which change as a result of changes in output/sales (e.g. raw materials, packaging) by a business
Fixed costs:
costs which don’t change in relation to output/sales of the business
How do you calculate total cost/cost of sales?
total cost/cost of sales = total variable costs + total fixed costs
Can fixed costs be avoided?
- fixed costs can’t be avoided if business is to be available to customers
- fixed costs can change but won’t change relative to the business’s output
Profit:
the moment a product is sold for more than it cost to produce, then a profit is earned
How do you calculate profit?
profit = total revenue - total costs
How do you calculate gross profit?
gross profit = revenue (turnover) - total costs (cost of sales)
How do you calculate net profit (operating profit)?
net profit (operating profit) = gross profit - fixed costs (expenses)
Breakeven:
- shows how many units a firm needs to produce and sell in order to cover its total costs
- point at which TR = TC and therefore no profit or loss is made
- total revenue = total costs
Why is breakeven useful?
- to identify output level needed - can act as a target
- to assess impact of change on breakeven point
- to support an application for a loan/investors
How is the contribution per unit calculated?
contribution per unit = sales price per unit - variable cost per unit
How do you calculate the margin of safety?
margin of safety = (actual/budgeted sales/output - breakeven sales/output)/current sales x100
What effect does a higher selling price have on the contribution per unit?
higher
What effect does a higher selling price have on the breakeven point?
lower
What effect does a lower selling price have on contribution per unit?
Lower
What effect does a lower selling price have on the breakeven point?
higher
What effect does a higher variable cost per unit have on the contribution per unit?
Lower
What effect does a higher variable cost per unit have on the breakeven point?
Higher
What effect does a lower variable cost per unit have on the contribution per unit?
Higher
What effect does a lower variable cost per unit have on the breakeven output?
Lower
What effect does an increase in fixed costs have on the contribution per unit?
No change
What effect does increase in fixed costs have on the breakeven output?
Higher
What effect does decrease in fixed costs have on the contribution per unit?
No change
What effect does decrease in fixed costs have on the breakeven output?
Lower
Strengths of break-even analysis:
- focuses on how long it will take before a start-up reaches profitability
- helps entrepreneur and finance providers to better understand the viability and risk factors
- margin of safety shows how much a sales forecast can prove over optimistic before losses are incurred
- illustrates the importance of keeping fixed costs down to a minimum
- calculations are quick and easy
Limitations of break-even analysis:
- unrealistic assumptions - products not all sold for same selling price at different levels of output changes
- sales unlikely to be same as output - may be some build-up of stocks or wasted output too
- variable costs per unit don’t always stay the same e.g. as output rises, business may benefit from being able to buy inputs at a lower prices (buying power)
- most businesses sell more than 1 product
- planning aid rather than a decision making tool
How to reduce breakeven output:
- maximise added value per unit sold: aim to maximise selling price
- negotiate to reduce cost of raw materials and other inputs (=lower variable cost)
- keep overheads or fixed costs under control
- increase price of product/service - may reduce breakeven point but may also deter customers from buying
How do you calculate breakeven point in units?
BE = fixed costs/unit contribution
Breakeven table example:
Breakeven graph example:
What does profit allow a business to do?
- survive
- reinvest profits for expansion
- providing security and savings
- reward employees
- generate wealth for the owner
How do you calculate interest on loans?
interest (on loans) % = (total repayment - borrowed amount)/borrowed amounts x 100
What is interest when saving and borrowing money?
- Saving £ - interest is the % reward for saving
- Borrowing £ - interest is the % cost of borrowing
Margin of safety:
- the amount of output between the actual level of output where profit is being made and the break even level of output
- this is how much the production could fall before the business starts to make a loss
How do you calculate the breakeven point in revenue / costs?
Breakeven point in revenue / costs = breakeven point in units x sales
How do total costs change as a business grows?
- key benefit of business growth is economies of scale
- a business’ costs will still increase as it grows, but the cost per unit will decrease
- as these are different forms of economies of scale but the most well known is purchasing economies of scale where businesses receive discounts for bulk buying from suppliers
