1.6 (Revenue, Costs, Profits & Cash)

Question 1

1.6.1 What are fixed and variable costs?
+ examples of each

How to calculate total cost?

Answer 1

Fixed: costs which don’t change with output (use)
+ e.g rent, employee salaries, insurance

Variable: costs which do change with output (use)
+ e.g stock, utilities, wages

Fixed Cost + Variable Cost

Question 2

How to calculate sales volume?

What is sales revenue and how do you calculate it?

Answer 2

number of units sold x period of time
total sales revenue/selling price per unit

Gross income produced through sales of products
(volume of good sold x average selling price)

Question 3

What are the 4 categories of cost?

Answer 3

• production
• premises
• staff
• sales/marketing

Question 4

1) What is revenue?

2) What is contribution per unit?

3) What is piece-rate labour?

4) What is operating profit?

Answer 4

1) The value of total sales made by a business within a period

2) The difference between selling price and variable costs

3) Paying workers per item they make

4) the amount remaining once all fixed and variable costs have been deducted from total revenue but before tax has been paid

Question 5

What Is average cost?
+How do you calculate it?

What is capital spending?

Answer 5

How much it costs to produce one item
+Total cost/number of units

When a business invests in premises or equipment or something of long term benefit to the business

Question 6

1.6.2 1) What is the margin of safety?

2) How to calculate break-even output?

3) How to calculate total contribution?

Answer 6

1) The amount by which current output exceeds the level of output necessary to break even

2) fixed cost/contribution per unit

3) contribution per unit x unit sales

Question 7

What is break-even revenue?

+ what is break-even point?

Answer 7

total costs=total sales revenue at a given output

+ the point at which total sales of a business equal total costs

Question 8

What is a break-even chart not related to?

+ How is PED important in relation to BE analysis?

Answer 8

Time

+ higher prices may mean fewer sales to break-even but these sales may take longer to achieve

+ lower prices may encourage more customers but higher volume is needed to break-even

Question 9

1) What is penetration pricing strategy?

2) What is market skimming pricing strategy?

+ what do these mean for break-even?

Answer 9

1) high volume, low price
+ more sales needed to break-even

2) low volume, high price
+ fewer sales needed to break-even

Question 10

Why would BE output increase?

+ Why would BE output decrease?

Answer 10

Rise in variable costs
Rise in fixed costs
Fall in selling price

+ the opposite of the above reasons

Question 11

Strengths of Break-Even Analysis

Answer 11

+ used to identify target levels of output
+ helps entrepreneur understand risk level
+ shows the importance of minimising fixed costs
+ shows margin of safety
+ graph is very visual
+ investors/banks can use it to see whether to lend/invest
+ shows effects of financial changes

Question 12

Limitations of Break-Even Analysis

Answer 12

• assumes all output will be sold
• assumes fixed costs never change
• ignores economies of scale
• less useful when a business sells multiple products
• hard to predict change in the structure of costs
• quickly out of date
• should be seen as a planning aid not a decision- making tool

Question 13

1.6.3
How is profit an incentive?

Answer 13

It drives free enterprise
Provides an incentive to work & create new businesses

Question 14

Examples of barriers to entering/exiting a market?

Answer 14

• contracts
• sunk costs
• advertising expenditure
• high fixed costs
• crowded market
• suppliers

Question 15

Chains of movement of resources

Answer 15

1) Falling demand & low prices
Falling revenue & profit
Resources exit the industry

2) High demand & high prices
Rising revenue & profit
Resources attracted: new entrants

Question 16

How is gross profit calculated?

+ why is it useful for businesses?

Answer 16

Revenue- cost of sales (variable costs)

+ allows a company to calculate the added value they earn on raw materials used in production

Question 17

How is operating profit calculated?

+ how firms measure profitability? What is another name for this?

Answer 17

Gross profit- other operating expenses (Fixed Costs)

+ profit/revenue x 100
(Profit margin)

Question 18

How is net profit calculated?
(What is another name for this?)

+ what is net profit?

Answer 18

Operating profit- interest
(Profit for the year)

+ final profit before any tax or dividends are paid

Question 19

What is a statement of comprehensive income?

Answer 19

Accounting statement showing a firm’s sales revenue over a trading period & all the relevant costs generated to earn that revenue

Question 20

1.6.4 What is cash flow?

+ How is it different to profit?

Answer 20

Net amount of cash and cash equivalents being transferred in and out of a company

+ profit only considers income & expenses at one point
+ profits are not spent in a firm
+ firms require liquid cash to pay bills

Question 21

Examples of 1) cash inflows and 2) outflows

+ How to calculate net cash flow

Answer 21

1) sales revenue, sale of assets, grants
2) salaries, supplier payments, loan repayments

Cash inflows- Cash outflows

Question 22

Causes of Negative Cash Flow

Answer 22

• low profits
• over investing
• poor financial planning
• late payments
• expensive overhead costs
• incorrect pricing of products

Question 23

What is a cash flow forecast?

+ why do businesses produce them?

Answer 23

a prediction of how cash will flow through a business in a period of time in the future

+ advanced warning of cash shortages
+ makes sure business can afford to pay suppliers & employees
+ spot problems with customer payments
+ important part of financial control
+ provides reassurance to investors & lenders

Question 24

Sources of information for a cash flow forecast?

+ what makes a good cash flow forecast?

Answer 24

• entrepreneurial experience
• market research
• suppliers
• advisers

+ updated regularly
+ makes sensible assumptions
+ allows for unexpected changes
+ based on good information

Question 25

What are opening and closing balances?
(How to calculate closing balance)

+ what does a negative closing balances suggest?

Answer 25

(O) - the amount of money in a business at the start of a month
(C) - the amount of money in a business at the end of a month

(Closing balance= opening balance + net cash flow)

+ the business needs additional financing or a bank overdraft

Question 26

What are cash flow problems?

+ Why do start ups often suffer cash flow problems?

Answer 26

when a business does not have enough cash to be able to pay its liabilities

+ won’t have retained profits
+ have to spend money on up-front costs
+ suppliers may demand immediate/early payment
+ can be a while before business makes its first sales

Question 27

Common problems/limitations of cash flow forecasts?

Answer 27

• sales prove lower than expected
• customers don’t pay on time
• costs prove higher than expected
• certain costs are missed
• unforeseen expenses hit the business
• competitors and how they may change the market are not accounted for
• based on predictions

Question 28

Ways to increase cash inflow?

+ ways to decrease cash outflow?

Answer 28

offer discounts for early payment
reduce credit time for customers

+ gain extra finance (bank loan)
+ set up an overdraft
+ negotiate trade credit with suppliers

Question 29

How is cash flow used to identify credit requirements and minimise risk?

+ How do some large businesses use payment delaying to exploit small suppliers?

Answer 29

• can help to identify where a business is spending more than it can afford
• can ensure there is sufficient overdraft available
• can outline if a firm is achieving its objectives
• helps precautions to be put in place for times of negative cash flow

+ businesses delay payment even further to decrease their cash outflow as small suppliers rely on them (however there is a legal limit in some countries)