Chapter 6 – Business Costs & Revenue Syllabus Unit – Business Finance and Accounting

You will learn …… Why businesses need to know the costs of running their activities and the revenue gained by selling their products The different types of costs involved in running a business How break-even analysis helps managers make decisions The purpose of budgets and financial forecasts

Business Costs Why do we need to know business costs? Comparing Costs & Revenue Determining Profit/Loss Comparing locations of a possible new site Price Determination

Business Costs List 10 costs that would be involved in opening and running a new factory making sport shoes

Business Costs Fixed Costs (FC) Do not vary with output in the short- term Paid regardless of output “Overhead Costs”

Business Costs Variable Costs (VC) Vary with output Costs directly associated with output “Direct Costs

Business Costs Total Costs (TC) Fixed Costs + Variable Costs

Break-Even The Break-even point (BEP) is the point at which cost or expenses and revenue are equal: there is no net loss or gain Break-even charts show; Costs Revenue Price x Quantity (P x Q) Level of sales to breakeven

Break-even

Break-Even Charts

Break-even Charts Namib Tyres Ltd produce motorcycle tyres. The following information about the business has been obtained Fixed Costs are $30,000 per year Variable Costs are $5 per unit Each tyre is sold for $10 Maximum output is 10,000 tyres per year Activity 6.3 Draw table on board. Students complete questions

Break-even Charts Advantages Identify break-even point of production Calculate maximum profit Expected profit/loss at different levels of output Impacts on BEP with various business decisions Helps in decision-making Margin of Safety

Break-even Charts Disadvantages Assumes all goods produced are sold Fixed costs constant only if scale of production doesn’t change Ignores other aspects of the business which need to be analysed Straight lines not realistic Ignores issues such as how to reduce wastage or increase sales

Break-Even Equation Breakeven Equation Total Fixed Costs Contribution Per Unit Contribution Selling Price – Variable Cost

Break-Even Equation A fast food restaurant sells meals for $6 each. The variable costs of preparing and serving each meal are $2. The monthly fixed costs amount to $3600 How many meals must be sold each month for the restaurant to break-even? If the restaurant sold 1500 meals in one month, what was the profit made in that month? If the cost of the food ingredients rose by $1 per meal, What would be the new break-even level of production?

More Business Costs Direct Costs Directly identified with each unit of production Vary with the level of output

More Business Costs Indirect Costs Not identified with each unit of production Associated with performing a range of tasks or producing a range of products Overheads

More Business Costs Marginal Costs Additional costs for producing one more unit of product Extra variable costs will be needed for that one extra unit

More Business Costs Average Cost Per Unit Total Costs Output Students complete Activity 6.5

Economies of Scale Purchasing Economies Bulk-buying discounts

Economies of Scale Marketing Economies Transport Advertising

Economies of Scale Financial Economies Lower interest rates

Economies of Scale Managerial Economies Specialists in all departments

Economies of Scale Technical Economies Specialisation Latest equipment

Diseconomies of Scale Poor Communication

Diseconomies of Scale Slower Decision-Making

Diseconomies of Scale Low Moral

Budgets & Forecasts Budgets Forecasts Plans for the future containing numerical or financial targets Forecasts Are predictions of the future

Reasons why businesses fail Do not consider future at all and make no plans Unprepared for unforeseen events

Budgets & Forecasts Managers try to predict/forecast Sales / Customer Demand Exchange rates of the currency Wage rises

Budgets & Forecasts A managers biggest problem is ……. uncertainty about the future

Forecasting Methods Trend An underlying movement or direction of data overtime This can be extended into the future

Forecasting Methods Line of Best Fit Figures plotted on graph (scatter diagram) Line extended into the future

Forecasting Methods Panel Consensus A panel of experts are asked for their opinions Most likely to be on future sales

Forecasting Methods Market Research Surveys Useful in forecasting sales that are yet to be launched onto the market No previous data exists

Budgets Plans for the future containing numerical and financial targets

Budgets Businesses plan months/years ahead Plan ahead for future reactions Future targets in numerical/financial terms

Budgets Budgets are set for; Revenues Costs Production Levels Raw Material Requirements Labour Hours Needed Cash Flow Master budget is derived from these smaller budgets

Budget and Forecasts

Budgets Advantages Departmental Target Setting Gives focus Motivates Variance Analysis Worker, Supervisor & Manager involvement Helps to control the business Variance Analysis Difference between budgetary figure and actual figure Worker, Supervisor & Manager involvement Motivates & More realistic budgets result More likely to work harder to achieve target if they have their say in setting it

Budgets Reviewing past activities Budgeting useful for: Planning for the Future Comparing actual with budgeted figures Controlling current business activity – Keeping to Targets Setting Goals to be achieved Students complete Activity 6.6 Page 102