Accounting Costs, Profit, Contribution and break Even Analysis

Content Costs – Fixed / variable –Direct / indirect Revenue Profit Contribution Break Even Analysis

Costs Fixed costs – these do not alter with output Variable costs – alter directly with the business’s level of output Total costs – are fixed and variable costs added together Semi variable – have a fixed and a variable element

Fixed Costs Examples – rent, management salaries, rates Graphically fixed costs will always be illustrated by a horizontal line As output changes fixed costs stay the same

Variable costs Examples – fuel, raw materials Graphically variable costs will always be a diagonal line from the origin As output changes variable alter directly

Graphical Representation

Direct / Indirect Costs Direct – are attributed to the production of a particular product and vary directly with output e.g direct materials and labour Indirect – Cant be allocated to the production of a specific product and relate to the business as a whole e.g. indirect labour costs, administration

Why do businesses calculate costs of production? For forecasting and budgeting To set prices so they make a profit To work out if they can make a profit

Revenue Revenue = Quantity Sold x Average Selling Price Generally if it reduces its selling price you expect to sell more A rise in price usually leads to a fall in quantity sold

Profits Profit = Total Revenue – Total Costs Profit depends on: –Profit margins – the amount or % of the final selling price that is profit –Quantity or volume sold –Total costs Profit is the main objective of firms in the private sector

Contribution Contribution is the total revenue – variable costs It measures how much is being contributed the fixed costs by the units that have been sold Contribution per unit = Selling price per unit – Variable cost per unit

Break even Analysis A business breaks even if it does not make a profit or a loss It is the point at which the business makes just enough revenue to cover their costs. In other words profit = 0 Businesses must make a profit to survive. To make a profit, revenue must be higher than costs.

Break even methods Break even analysis can use a number of methods: –Contribution method –Break even chart –Break even graph

The Contribution Method This involves a two part calculation: Selling Price per unit – variable cost per unit = contribution (towards fixed costs). AND Fixed costs divided by contribution = Break even point.

Break Even Diagram

Profit or Loss LOSS TC > TR

Summary Costs can be classified into fixed (don’t change with output) and variable (change with output) Direct costs are costs directly related to the costs of producing an item, indirect costs are not directly related Revenue – sales revenue x quantity Profit = Total costs – Total revenue Profit is the number one objective of most firms in the private sector Contribution – Selling price – variable cost, it looks at how much each unit is contributing to fixed costs Break Even Analysis – where a business makes neither a profit or a loss Break even equation = Fixed costs / contribution per unit