2.2 (Done) Flashcards
Define average cost.
The cost of producing one unit.
Define profit.
The financial gain of a business through trading.
Define sales volume.
The quantity of output sold in a particular time period.
Define total revenue.
The amount of money the business receives from selling output.
Define sales revenue.
The value of output sold in a particular time period.
What is the formula for sales revenue?
Price X Quantity of output
What are four examples of business costs?
- Wages.
- Raw materials.
- Insurance.
- Rent.
What is the ‘short run’?
The period of time when at least one factor of production is fixed.
Explain the example of a firm wanting to expand production in its factory in the short run.
In the short run, a firm can acquire more labour and buy more raw materials but it has a fixed amount of space in the factory and a limited number of machines.
Using the same example of the factory, what can the firm do in the long run?
In the long run, the firm can buy another factory and add to the number of machines, increasing its capacity.
Define fixed costs.
Costs which stay the same at all levels of output in the short run.
What are two examples of fixed costs?
- Rent.
- Insurance.
What is a reason why fixed costs could increase?
Inflation.
What are variable costs?
A cost that rises as output rises.
What are two examples of variable costs?
- Raw materials.
- Wages.
Define total cost.
The entire cost of producing a given level of output.
What is the formula for total cost?
TC= Fixed cost + Variable cost
What is the formula for average cost(unit cost)?
Total cost
——————
Output
What is the formula for profit?
Total revenue - total costs
Define contribution.
The difference between selling price and variable costs.
What is the formula for Contribution per unit?
Selling price - Variable cost.
What is an example of working out contribution?
If I bought a watch for £150 and sold it for £250 then the contribution is £100. This £100 will contribute to the fixed costs of the business and the profit.
What are the two formulas for total contribution?
Total revenue - Total variable cost.
Unit contribution X Number of units sold.
What is the break-even point?
Where total costs are exactly the same as total revenue.
What is the break-even output?
The level of output a business needs to produce so that total costs are exactly the same as total revenue.
What is the formula for break-even output using contribution?
Fixed costs
Break-even output= —————————
Contribution
Define margin of safety.
The range of output between the break-even level and the current level of output, over which a profit is made.
How can the margin of safety be identified on the break-even chart?
By measuring the distance between the break-even level of output and the current (profitable) level of output.
Why do businesses prefer to have a large margin of safety?
Because if sales drop they still might make a profit.
What are three questions that break-even analysis helps to answer?
- If the price went up, what would happen to the break-even price.
- What will happen to the break-even point if costs are forecast to rise?
- If the business introduced a new product line, how many would the new product have to sell to at least break-even?
Give a reason why break-even analysis can be very important to a business.
Break-even analysis is found in business plans so it might be vital in gaining finance from banks.
What are three limitations of break-even analysis?
- It assumes that all output is sold, so that output equals sales, and no stocks are held.
- The break-even chart cannot cope with a sudden increase in wages and prices or changes in technology.
- The break-even calculations are only as accurate as the data they are based on.
What is the formula for margin of safety?
Actual sales - break-even level of sales
Define a budget.
An estimate of income or expenditure for a set period of time.
What are four reasons why a business will create budgets?
- Planning.
- Forecasting.
- Communication.
- Motivation.
How does a budget help planning within a business? (2)
- Can plan for any expenses in the year.
- Can identify where and when a business may run into financial problems.
How does a budget help a business with forecasting?
Using the business’ sales and expenditure forecasts, they can prepare projected profits for the next 12 months.
How does a budget help communication within a business?
Setting up a budget is an ideal opportunity for the owners to communicate their objectives of the business in a financial plan.
How can a budget motivate staff? (2)
- Can motivate staff to be more careful with the finances.
- Provides workers with targets and standards.
What are the two types of budget?
- Historical budget- set using current financial figures and based on historical performance of the business.
- Zero-based budget- set by using figures based on potential performance.
What is an advantage of a historical budget?
It’s realistic because it’s based on last year’s sales.
What are some drawbacks of a historical budget?
Doesn’t take into account shocks, uncertainty, dynamic markets or actions of competitors.
What is an advantage of using a zero-based budget?
Can be used by a start-up with no historical data.
What are three difficulties of budgeting?
- Tendency for managers to spend up to the limit.
- Time consuming to prepare, monitor and control.
- Unrealistic budgets can be demotivating.
What are two limitations of budgeting?
- Can cause inter-department rivalry as some departments get more than others.
- Can make managers short-term and short-sighted.
Define variance.
The difference between actual financial incomes.
Define variance analysis.
The process of calculating variances and attempting to identify their causes.
What are five examples of variances?
Wages, materials, overheads, profit and sales revenue.
What is favourable variance?
When a manager has underspent, and so cut costs, impacting profits.
What is adverse variance?
Overspending.
Why might a manager overspend their budget?
Due to needing more staff than was budgeted for.
