Costs and Revenues Prepared by :Dr.Hassan Sweillam

Costs Definition of Cost : Cost refers to resources sacrificed to achieve a specific objective It is the total amount of money it takes to produce an item (to pay for all Factors of Production).

Management Decisions and Cost Business decisions cannot be made without cost information. Why? Profit or loss cannot be calculated without knowing COST Marketing will use COST information to determine pricing COST records are useful in comparing to past performance and help set budgets COST data can help determine the use of resources…use labor hours or buy automated equipment?

Production Costs Costs are classified into categories: 1- Direct Costs 2- Indirect Costs 3- Fixed Costs 4- Variable Costs 5- Marginal Costs

1-Direct Costs Direct Costs definition: Costs that can be clearly identified with each unit of production and can be allocated to a cost center. e.g. Direct costs of a hamburger in a fast-food restaurant is the cost of meat. e.g. Direct cost for a business studies department is the salary of the teacher. Common direct costs in manufacturing are labor and materials. Common direct costs in a service business is the cost of goods sold.

2-Indirect Costs Indirect Costs definition: Costs which cannot be identified with a unit of production – also known as overhead costs e.g. Indirect cost to a farm is the purchase of a tractor. -Indirect cost to a automobile repair shop is rent -Indirect cost of running a school is the cost of cleaning.

2- Indirect Costs , cont. Indirect Costs can be classified into 4 groups: Production overheads – factory rent, electricity Selling and distribution overheads – warehouse, packing, and distribution costs Administration overheads – office rent, clerical salaries Finance overheads – interest on loans

3-Fixed Costs Fixed Costs Definition : It is the amount of money a business MUST pay each month or year (like rent and Capital expenses).

4- Variable Costs Variable Costs definition : the amount of money a business pays that changes over time (Labor and Raw Materials).

5- Marginal Costs Marginal Costs : The additional Cost of the NEXT UNIT produced. Margin=Extra Space

Costs Total Costs definition : Total Costs = Fixed + Variable Costs.

Revenues Definition of Revenues : It is the total amount of money the government takes in at Macro level of economy and the money that comes into the firm from the sale of their goods and services at Micro level of economy.

Revenues Revenue is the income received from the sale of a product Total Revenue is the total income from the sale of ALL units of the product (quantity X price)

Objectives of the Firm Why do people do business? What motivates the owners /investors / promoters to take so much of risk and conduct their own businesses, rather than going for a secured employment? Is it only maximization of profits that drives businesses?

Profit Maximization Theory Objective of business is generation of the largest amount of Profit = (Total Revenue - Total Cost) Traditionally, efficiency of a firm measured in terms of its profit generating capacity

Costs and Revenues Profit definition : The money that business made as difference between Total Costs and Revenues. This is WHY you’re in BUSINESS (Profit Motive!) Profit=Revenues-Total cost Profit Motive=why you are in business---to make MONEY (principles of Capitalism)

Costs and Revenues Cost Benefit Analysis Definition : Weighing the Marginal Costs vs. the Marginal Benefits of producing an item and if and only if the Benefit is GREATER than the Cost, then business does it. Marginal Costs Marginal Benefits

Cost-Benefit Analysis Economics studies how people make choices under conditions of scarcity, how people think rationally according to cost and benefits approach. In order to take wise decision; action should be taken if, and only if, its benefits (returns/pleasure) exceed its cost (expenses/effort).

Cost-Benefit Analysis Immediate or short term satisfaction can lead to missing the long-term benefits. For Example Immediate spending on cheap stuff instead of long-term savings will lead to lower economic prosperity.

Review questions True or False Questions 1- Costs are classified into four categories. Answer: False 2- Indirect Costs can be classified into four groups. Answer: True

Review questions True or False Questions 3- Marginal Costs are the additional Cost of the next unit produced. Answer: True 4- Profit is the total income from the sale of ALL units of the product . Answer: False

Review questions Multiple Choice Questions 1- _________ which cannot be identified with a unit of production . A- Direct Costs B- Fixed costs C- Indirect Costs D- Variable Costs Answer: C

Review questions 2- ____________ is the money that business made as difference between Total Costs and Revenues. A- The Profit B- The total revenue C- The income D- None of these Answer: A

Review questions 3- _______________ Weighing the Marginal Costs vs. the Marginal Benefits of producing an item. A- Marginal analysis B- Cost analysis C- Benefit analysis D- Cost Benefit analysis Answer: D

Review questions Brief explain Questions 1- Briefly explain the basic types of Indirect Costs ? 2- Briefly explain the Profit Maximization Theory ? 3- Briefly explain the Cost Benefit Analysis ? Brief explain Questions