Chapter 26- costs, revenue and profit Flashcards
1
Q
How do businesses make a profit?
A
- businesses has to ensure that its revenue (income from the sale of its products or services) exceeds its costs
2
Q
Where is careful control of costs essential?
A
- if the business is operating in a competitive market where its not easy to alter prices
3
Q
What is one of the most common ways for a business to cut costs?
A
- reduce its number of employees
4
Q
Fixed costs
A
- these are costs that don’t change as output or sales change
- they have to be paid whether sales are 10 or 1000
- e.g. factory buildings have to be paid for usually in the form of interest on a loan
- interest is a fixed amount that the business pays regularly irrespective of the level of production
- cost of machines used to make the products are a fixed cost
- those who administer the business all have to be paid even before production has begun
- marketing activities are also a fixed cost because the advertising has to be paid for irrespective of the level of sales that is achieved
5
Q
What can fixed costs also be called?
A
- overheads or direct costs
6
Q
Overheads/ indirect costs
A
- costs that can not be attributed to a particular unit of output
7
Q
Stepped fixed costs
A
- these costs are referred to as fixed costs
- more accurate to suggest there fixed in the short term
- if production continues to increase it might be necessary to purchase an additional machine to cope with the extra production required
- fixed costs have increased by only in order to meet the increase in production
- actual cost of purchasing the machine remains the same
8
Q
What is an increase in fixed costs referred to as?
A
- ‘stepped fixed cots’
9
Q
Variable costs
A
- costs that are directly related to the level of output or sales
- variable costs increase when output increases and fall when output falls
- variable costs are often stated per unit
- unlike fixed costs when production is 0, variable costs are 0
- such costs can be shown as a straight line which slopes upwards as output increases
10
Q
What are variable costs sometimes known as?
A
- direct costs
11
Q
Direct costs
A
- costs that are directly attributable to a unit output (the raw materials)
12
Q
Total costs
A
Fixed costs + variable costs
13
Q
Why does the total cost line start above 0?
A
- because of the fixed costs
14
Q
Unit cost
A
- the cost of producing one unit
Total costs/ output
15
Q
What is a useful way for a business to survive in a competitive market?
A
- reducing unit costs
16
Q
Average costs
A
Fixed cost + variable costs/ output
17
Q
What is the fall in unit costs mainly due to?
A
- the fixed costs being spread over a greater number of units
18
Q
Marginal cost
A
- the cost of producing one extra unit
19
Q
Social cost
A
- the implications of a business decision are not always included in the businesses own costs
E.g. tobacco company producing cigarettes has to pay for the manufacturing process and the marketing and distribution of its cigarettes but doesn’t pay the negative costs of treating people who are diagnosed with cancer as a result of smoking
20
Q
Opportunity cost
A
- it is related to what a business could have spent money on
- it is the next best alternative that had to be given up to spend the money on the first choice
21
Q
Price, revenue and total revenue
A
- revenue is the cash that flows into a business from the sale of goods or services
- amount of revenue will be determined by the number of sales of a product/service and the price that is charged for the products/service
- if the price is constant the total revenue line will be a straight line
- however if the price increased, the gradient of the total revenue line also increases
- this change in the gradient of the total revenue line will also have an impact upon the break even levels
22
Q
Average revenue
A
Total revenue/ number of sales
23
Q
What happens when price is reduced?
A
- sales increase
- sales revenue increases
- to achieve the additional sales average revenue for each good sold falls
- much will depend upon the elasticity of demand of the product/service sold
24
Q
Impact of costs and revenue on a business
A
- costs influence both the price that a product may be sold for and the level of profit for a business
- if costs are high, assumption that a profit is required so the price must reflect the costs and be higher to ensure a profit is made
- reducing costs allows a business to increase its profit margin and gives it the ability to deliver higher profits
- degree of competition within market will also influence the level of the price and subsequent profit margin
- in a highly competitive market the profit margins may be small and therefore every reduction in costs allow the business to be more competitive
- revenue provides the business with the cash to purchase raw materials and pay for other costs such as overheads
25
Standard costing
- the cost that the business would normally expect for the production of a particular product or to complete a particular activity
26
Variance
- the difference between the standard cost and the actual cost
27
Use of standard costing
- helps a business to monitor its performance
28
Advantages of standard costs
- give a business a good idea of the target cost they should be aiming for
- give employees a target to aim for and can alert them to problems as and when they arise
- be used within the reward and motivation policy of the business so that bonuses could be offered when positive variances are achieved
- encourage workers to look for better and more efficient ways of completing a job so as to achieve positive variances
29
Disadvantages of standard costs
- collecting information to arrive at a standard cost may be time consuming. Process will need to be repeated at regular intervals especially in periods of rapid inflation and in changing business environments
- use of standard costing especially when tied to bonuses for workers may result in a situation where quality is sacrificed to keep costs of production down. Won’t be helpful to the businesses in the long term
- if the business is not careful in recessing the figures used periodically, it may find that standard cost has become an inaccurate measure of the actual cost because so many factors have changed
30
Cost centres
- a cost centre is a specific part of a business where costs can be identified and allocated with reasonable ease
31
There are a number of ways in which a business can choose to allocate costs to cost centres these include:
- product being produced
- indivual department
- location
- capital equipment
- physical size
32
Benefits of using cost centres
- information will help to highlight those departments that are performing well and those that are not making it possible for management to make the necessary changes
- information gained can be used to help motivate the workforce
- availability of the information may encourage management to look for new suppliers or more efficient production techniques to bring costs down
33
Disadvantages of using cost centres
- may result in conflict and lack of motivation
- act of collecting and separating out the information into different cost centres is likely to be expensive in terms of time and money
- in some businesses it’s difficult to separate out the costs into different departments- there may be an overlap in the production process
- the way in which costs are allocated can have a significant effect on the performance of a particular cost centre
- some of the costs for a business may be outside its control
- if the allocation of costs is felt to be unfair or unreasonable it may lead to conflict
34
Profit centres
- similar to a cost centre
- except that profits coming in are ascribed to different parts of the business
- from this management can judge which products, outlets or divisions are the most profitable parts of the firms operations
35
Absorption costing
- all the indirect costs or overheads of a business is absorbed by different cost centres
- method used for allocating overheads to different cost centres will vary
- easiest method is to use the output of each unit or its proportion of direct costs to allocate the overheads
- this costing method will be time consuming and expensive to complete
- also a risk that information is old and does not represent the current situation
- main benefit of absorption costing is that it ensures that all overheads are covered somewhere in the business
36
What is the alternative of absorption costing
- full costing
- this takes all the overheads of the business and divides them using one simple criterion
37
Contribution or marginal costing
- method whereby fixed costs or overheads are ignored and the business considers only the variable costs of production
- contribution is the selling price of a product - variable cost of producing it
- this can be calculated as a total across all production or the contribution may by each extra unit produced
- once the variable cost has been covered anything left over can be used as a contribution towards fixed costs
38
Contribution per unit
Price-variable costs
39
Total contribution
Sales x cpu
40
Usefulness to stakeholders
- shareholders will look at the ‘bottom line’ (level of profit) as it will affect their dividends
- employees may be affected by the accuracy and relevance of the method used and therefore this will impinge upon sales and therefore the likelihood of retaining their job or gaining any bonuses that may be linked to profits
- management decisions will be made on the basis of the costing methods used and therefore their reputation may be affected
- suppliers will be affected by how much a business is prepared to pay for its supplies which in turn will be influenced by the method of costing used
- banks and other loan sources will look at the level of profits to help assess the ability of a business to pay back any such loan
