5.2 Costs and Revenues Chapter 31

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 The financial costs incurred in making a product or providing a service. Costs are classified into categories:  Direct Costs  Indirect Costs  Fixed Costs  Variable Costs  Semi-Variable Costs  Marginal Costs

Direct Costs  Costs can be clearly identified with each unit of production and can be allocated to a cost center. Direct costs of a hamburger in a fast-food restaurant is the cost of meat…. You name another Direct cost for a automobile repair shop servicing a car is the labor of the mechanic…You name another Direct cost for a business studies department is the salary of the business teacher…You name another  Common direct costs in manufacturing are labor and materials.  Common direct costs in a service business is the cost of goods sold.

Indirect Costs  Costs which cannot be identified with a unit of production – also known as overhead costs Indirect cost to a farm is the purchase of a tractor…. You name another Indirect cost to a automobile repair shop is rent… You name another Indirect cost of running a school is the cost of cleaning… You name another

Indirect Costs Indirect Costs can be classified into 4 groups: 1.Production overheads – factory rent, equipment depreciation, electricity 2.Selling and distribution overheads – warehouse, packing, and distribution costs 3.Administration overheads – office rent, clerical salaries 4.Finance overheads – interest on loans

Costs are affected by Output Some costs vary with output of production and some costs do not change. Costs can be classified:  Fixed costs – These remain constant no matter what happens to production output (rent)  Variable costs – These vary as production output changes (quantity of raw materials used)  Semi-Variable costs – These include both fixed and variable costs (account charge for electricity plus the electricity used)  Marginal costs – The additional variable cost of producing one more unit

Revenue 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)

Don’t confuse Revenue, Cash Flow, and Profit Remember: Revenue is not the same as cash received from sales.  Revenue is recorded at the time of sale not at the time cash is received. Remember: Revenue is not the same as profit.  All costs of operating the business are subtracted from revenue to determine profit.

Contribution to Fixed Costs Contribution per Unit Is the selling price of a product less variable costs per unit. Total Contribution Is the total revenue from the sale of a product less total variable costs of producing it. Contribution is NOT profit. Contribution is what a product “contributes” towards fixed costs, and once these are paid, towards the profits of the business.