Unit 19 : Costs, Scale of Production and Break-Even Analysis Flashcards
Define Fixed Costs
costs which don’t vary in the short run according to the number of items sold / produced. they must be paid whether or not the business is making sales.
Define Variable Costs
costs which vary directly with the number of items being sold / produced
Formula for Variable Costs
variable cost = total cost - fixed cost
2 Formulas for Total Cost
- fixed cost + variable cost
- average cost per unit x output
Formula for Average Cost per Unit
total cost of production divided by total output
5 Usages of Cost Data
- setting prices
- deciding whether or not to stop production
- deciding the best location
- helps managers make decisions
- needed to calculate profit and loss
Define Economies of Scale
the factors that reduce average costs as a business grows
Define Purchasing Economies
when a business buys in bulk, it tends to receive discounts, decreasing the price of each good
Define Marketing and Selling Economies
when the company advertises for goods, it will pay the same amount to advertise a greater number. therefore, when marketing for a higher output, unit costs fall, decreasing ATC.
Define Financial Economies
banks tend to lend to larger companies with low-interest rates, as they borrow high amounts and their collateral value is high
Define Managerial Economies
large firms have opportunities to employ specialists who will help reduce wastage and increase efficiency and productivity
Define Technical Economies
more capital to invest in newer, more efficient technology and specialist equipment
Define Diseconomies of Scale
the factors that lead to an increase in average costs as the business grows beyond a specific size
Explain Poor Communication as a DEOS
the larger the organization, the harder it is to communicate
Explain Lack of Commitment from Employees as a DEOS
large businesses have many employees, and not everyone is connected to the top management, reducing their motivation levels
Explain Slow Decision-Making & Weak Coordination as a DEOS
large businesses have longer chains of command, so information and instructions take longer to reach the desired person, slowing communication and decision-making
Define Break-Even Level of Output
the quantity that must be produced/sold for total revenue to equal total costs. (also known as break-even point)
Define Break-Even Charts
a graph showing how the costs and revenues of a business change with sales. they show the level of sales the business must make to break even.
Define Revenue
the income during a period of time from sales of goods
Define Break-Even Point
the level of sale at which total costs = total revenue. the point where they intersect in the graph
Break-Even Formula
total fixed costs divided by contribution per unit
Contribution per Unit Formula
selling price - variable cost
3 Benefits of Break-Even Charts
- managers can use it to check if they should expect profits or losses
- it lets managers try out different possibilities to see what works
- it shows the safety margin which is the number of sales that exceeds the break-even point.
Formula for Margin of Safety
total units of production - break even quantity
4 Limitations of Break-Even Charts
- assumes that all products made will be sold
- fixed costs only stay the same if scale of production stays the same
- assumes that costs and revenues can be drawn with a straight line which is unrealistic
- assumes costs and revenue increase at a constant rate
