tutor2u ™ gcse business studies revision presentations 2004 costs & break-even

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GCSE Business GCSE Business StudiesStudiesRevision Presentations 2004Revision Presentations 2004

Costs & Break-Even


GCSE Business GCSE Business StudiesStudies

Introduction

A business has many different costs, from paying for raw materials through to paying the rent or the heating bill

By careful classification of these costs a business can analyse its performance and make better-informed decisions.

The main ways in which a business needs to manage its costs are as follows:

Classification of costs into fixed and variable, direct and indirect

Variance analysis to see if the business is keeping control of its costs

Break even analysis which tells a business what it needs to sell to cover its costs



Variable and Fixed Costs

Variable costs

Change in proportion to amount of output produced; E.g.

Raw materials

Workers wages

Energy/fuel for machines

Fixed costs

Remain same, no matter how much business produces. E.g.

Rent

Salaries of head office workers

Heating and lighting

Insurance



Semi-Fixed Costs

Costs which are normally fixed, but change (i.e. become variable) as the business reaches stages of growth

Costs which only change when there is a large change in output

For example, costs associated with buying a new machine to cope with increased production



Standard Cost

A way of estimating what the likely cost of something is going to be

Cost per unit of production when product is made with:

Correct quantity and quality of materials, and

In exact time allowed for its production

Standard costs are often used in the preparation of the annual production / cash flow budget

Estimate what raw material and production labour costs will be based on the expected level of output

Can then compare actual costs against standard



Variances

When ACTUAL cost is either greater or less than standard cost

Where actual costs are more than standard = “adverse variance”

Where actual costs are less than standard = “positive variance”

Costs for January

Budgeted (£) Actual (£) Variance (£)

Wages 2,000 1,950 50 Positive

Materials 6,500 7,500 1,000 Adverse

Fuel 350 375 25 Adverse



Using Standard Costing to Manage a Business

A variance (difference) from standard may indicate what course of action to take to correct something which is going wrong

A greater cost than standard (“adverse variance”) might lead to an investigation into how inputs were being used

E.g. too much waste of raw materials, incorrect operation of machinery



Opportunity Cost

Financial benefit forgone of next best alternative use of money

A business can measure outcome of a decision by comparing it with benefits (profits or revenue) it could have had if it had taken next best option

Opportunity cost of buying a new piece of machinery might be compared with spending money instead on a new advertising campaign



Direct and Indirect Costs

Direct costs

Costs which can be identified directly with production of a good or service

E.g. raw materials

Indirect costs

Costs which cannot be matched against each product because they need to be paid whether or not production of good or services takes place

E.g. rent on premises



Break-even Point

Point at which contribution from number of units sold exactly equals all fixed costs of business

Profit is made above break even point when number of units sold exceeds number of units at break even point

Contribution

Amount of money each unit sold contributes to pay for fixed and indirect costs of business.

Contribution = selling price less variable cost per unit

E.g. a product sells for £15 and has variable costs per unit of £11. Each unit sale therefore makes a contribution of £4 towards fixed costs of business. If business had fixed costs of £20,000, then it would need to sell 5,000 units (£4 x 5,000 = £20,000 contribution) in order to break even



Break Even Chart - Example



Importance of the Break-even Point

Contribution from every unit sold above breakeven point adds to profit

Breakeven point provides a focus for business

Also helps it work out whether forecast sales will be enough to produce a profit and whether further investment in product is worthwhile.

How calculated

Number of units needed to break even is calculated by:

FIXED COSTS

SELLING PRICE - VARIABLE COSTS



Limitations of Break-even Charts

Do not take into account possible changes in costs over time period

Do not allow for changes in selling price

Analysis only as good as quality of information

Do not allow for changes in market conditions in time period – e.g. entry of new competitor

tutor2u ™ gcse business studies revision presentations 2004 costs & break-even

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