Unit 5.2: Costs and Revenues Examine types of costs and sources of revenue Explain the role of contribution IB Business Management

Cost, Revenue, Profit Cost: expenditure in producing a product. NOT what it costs the consumer Revenue:$ a business receives from the sale of products Profit: revenue - costs

Types of Costs Fixed Costs: Don’t change over short term, must be paid regardless of quantity produced/sold (even if there are no sales/output) Examples: Rent, Salaries, Insurance, Loan payment Advertising FC CAN change overtime, but are independent of level of output

Types of Costs Variable Costs: Change in direct proportion to the level of output or sales (if amount of output/sales doubles, variable costs also double) Examples: Raw materials, sales commission, wages, packaging costs

How to find Total Cost (TC)? Formula for finding TOTAL COST? TC = TVC + TFC

Types of Costs Semi-Variable Costs: Contain elements of both fixed & variable costs, typically change when business exceeds certain level of sales/output Examples: Exceeding minutes on cell phone plan, overtime pay, machinery maintenance

Practice Classify the following costs for an airline as fixed, variable or semi-variable: Onboard drinks Advertising & promotions Airport fees Fuel Pilots’ salaries

Types of Costs Direct Costs: Costs specifically related to a particular project or to the output of a single product (would not occur if this project/product didn’t exist). Similar to variable cost Examples: Costs involved if your shoe company begins making t-shirts: machinery, workers’ wages, materials, design & research

Types of Costs Indirect Costs (overhead): Costs that can’t be related to the level of output for a single product because they apply to all or several areas of the business Similar to fixed costs Examples: Utilities, insurance, rent, management salaries, advertising, legal expenses

Practice Classify the following costs for an airline as direct or indirect: Onboard drinks Advertising & promotions Airport fees Fuel Pilots’ salaries

Average Cost Average Cost: cost per unit Total cost/output Q = 1,000 TC = $8,000 AC = ? Comprised of: Average fixed costs (AFC) = TFC/Q Declines continuously as Q increases Average variable costs (AVC) = TVC/Q

Revenue Proceeds coming into a business, usually from the sale of goods and/or services Revenue from the sale of a firm’s products is called sales revenue Formula: Price x Quantity Sold

Revenue Example If a business charges $60 for each pair of its shoes and sells 100 pairs in a week, its total sales revenue is: $6,000 = $60 x 100

Revenue Other sources of revenue besides the sale of goods/services: Subventions: similar to subsidies Grants: government assistance Donations: financial gifts Fundraising: used by non-profit firms Sponsorship: below-the-line promotion Interest: from investments Dividends: payments from holding shares Sale of assets : firms sell assets for cash

Contribution The amount of money (per unit) that remains after all direct and variable costs have been subtracted from the sales revenue for that product Formulas: Contribution per unit = P - AVC Avg. Variable Cost = Total Var. Cost Quantity

Contribution Example School kids sells CDs for $12 each Direct & variable costs are $8 per CD Contribution = $12 - $8 = $4 This isn’t profit because fixed & indirect costs haven’t been paid yet Each CD contributes $4 toward the payment of fixed & overhead costs Therefore: Profit = Contribution – TFC

Contribution Analysis Why do businesses care about contribution? Contribution analysis helps business identify areas that are profitable and areas that need more attention