What do you think:

Write your ideas….

Why is profit so important to a

business?

Calculating Costs

• Define and give examples of the different types of production costs· Fixed, Variable, Semi-variable· Direct, Indirect/overheads

• Explain the meaning of revenue and comment on sources of revenue for different firms

• Understand the uses to which cost data can be put

• Explain and calculate the contribution to fixed costs

• Explain the nature of cost and profit centres and analyse their value HL

• Analyse product viability using contribution analysis HL

Learning Objectives:

CostsCosts

• Aim: • Define and give examples of the different

types of production costs.

· Fixed, Variable, Semi-variable

· Direct, Indirect/overheads

HW: Ch 16 Q. 1 & 2 pg 65 & 67

Hungry Horace’s Pizza factory

What are the costs involved in starting a pizza factory?

Objectives of a firm

What is the main aim of a business?Does Horace have a desire to provide

the world with pizza? Does he have a love for the pizza business?

More likely to make money!Most business goals are to maximise

profit.What is a business’ Profit?

Profit

The amount that a business receives from the sale of its output (pizza) is called total revenue.

The amount that the firm pays to buy the inputs (flour cheese, workers, ovens, etc) is called total costs.

Profit is a firm’s total revenue minus total costs.

That is: PROFIT = Total revenue – Total costs. Horace objective is to make his firm's Profit as

large as possible.

Firstly we must understand costs..

Costs are the expenses incurred by a business in producing and selling its products

START UP COSTS

Activity

Brainstorm all the costs a business would need to incur before starting a business:

In Pairs

Start up costs

Market research Premises (purchase price or rent deposit) Any building alternations Fixture and fittings Legal/ professional fees Equipment Furniture Communication equipment Advertising/ promotional materials Insurance Utilities Transport Business stationary Licences and permits.

Start Up costs

Start up costs are costs which need to be met before a business can start selling the new product

Running Costs

Otherwise known as Operating costs.Running costs need to be met so that a

business can go through the day-to-day process of producing and selling their products.

Activity

Brainstorm running costs for a business:

In Pairs

Running Costs

Salaries Insurance premiums Rent/lease payments utility payments Business rates Accountancy fees Raw materials or stock Loan repayments Packaging materials Tax Postal and distribution charges

Some key words….

Direct costs: These costs can be clearly identified with each unit of production and can be allocated to a cost centre.

Indirect costs: Costs that cannot be identified with a unit of production or allocated accurately to a cost centre - also known as overhead costs.

Fixed costs: Remain unchanged no matter what the level of output, such as rent of premises.

Variable costs: Costs that vary with output, such as purchases of flour at a bakery.

Fixed and variable

Running Costs can be split into fixed and variable costs

Costs

Fixed costs (also called INDIRECT or OVERHEADS) have to be paid even if no products are sold

DO NOT VARY with OUTPUTNo matter how many items are produced

or sold these costs remain the same.They are therefore include all the

general business overheadsBrainstorm three examples:

There are two types of costs: Variable costs (or DIRECT) increase by a

step every time an extra product is sold (eg cost of pizza topping etc.)

DO VARY with OUTPUT The more goods are produced or sold the

higher the variable costs. They include raw material, packaging, sales,

commission payments, piece rate pay.

Split into fixed and variable costs for Hungry Horace’s Pizza factory

FIXED COSTS VARIABLE COSTS

Semi-Variable Costs

Fixed and variable costs are convenient. However, not all costs are easily classified.

Take a delivery vehicle operated by a local bakery. Many operating costs of this vehicle are fixed –

Insurance, road licence. However, if demand raises sharply, transport costs will

rise as the business increases it’s delivery. More fuel will be needed, more services, more

mileage, wear and tear. In these circumstances we should say that this vehicle

costs is semi-variable, i.e. part fixed part variable.

Marginal costs

Marginal costs: The extra cost of producing one more unit of output (additional variable costs), such as the extra cost of producing loaf of bread number 101 after having already produced 100 loaves.

Total Costs

When added together, fixed costs and variable costs (plus any semi-variable costs) give the total costs for a business.

TVC + TFC = TCEasy to calculate but what does it mean?

Total Costs

If a business has high fixed costs, then they would want to maximise sales to ensure they the fixed costs are spread across many units of output as possible.

Total cost:

TVC + TFC = TC Managers need to know this to make

decisions on how many to produce and the resources to do so.

They can also use the total cost figure to calculate how much each individual product cost to make.

Total cost per unit =Total cost

Number of units produced

Why calculate costs of production?

When starting a new businessA forecast of profit or loss to be madeForecast breakevenCash flow forecast to be drawn up so

that financial planning is undertakenPricing decisions to be made based on

cost data

Why calculate costs of production?

When business is up and running: Keeping a check of actual costs against the

forecasted costs that were part of the original business plan (is the business exceeding these costs and why)

Using cost information to help on pricing decisions

Calculate whether costs are greater or less than revenue (is the business profitable)

Why do managers need to be aware of the costs of all aspects of their business?

They need to know the costs of production to assess whether it is profitable to supply the market at the current price.

They need to know actual costs to allow comparisons with their forecasted (or budgeted) costs of production. This will allow them to make judgements concerning the cost efficiency of various parts of their enterprise.

They also need to know if they have sufficient finance to afford the expected costs.

Activity

In pairs consider starting a takeaway sandwich shop.

You have one full time employee (40 hours a week)

Two part time employees (15 hours each) Make a list of all your start up costs (assume

you rent) Make a list of all the running costs Assume your shop will take four months to get

popular. Estimate the minimum amount of money you think you will need to raise to start the business.

In groups of four

Activity:

Compare answers

How easy do you think it is to plan the finance for this business?

Why do you think planning is important to the success of a business?

Revenue & Profit

Explain the meaning of revenue and commenton possible sources of revenue

Recap

Define:Start up costsRunning Costs

Profit

What is the formula for working out profit?

That is: PROFIT = Total revenue – Total costs.

Fixed and variable

Running Costs can be split into fixed and variable costs

Define Fixed cost: DO NOT VARY with OUTPUT Two other names for Fixed cost: Fixed costs (also called INDIRECT or OVERHEADS)

Define variable cost:DO VARY with OUTPUTOne other name for a variable cost?Variable costs (or DIRECT)

Total Costs

What is the formula for total cost?TVC + TFC = TC

Why calculate costs of production?

When starting a new businessA forecast of profit or loss to be madeForecast breakevenCash flow forecast to be drawn up so

that financial planning is undertakenPricing decisions to be made based on

cost data

Why calculate costs of production?

When business is up and running: Keeping a check of actual costs against the forecasted

costs that were part of the original business plan (is the business exceeding these costs and why)

Using cost information to help on pricing decisions Calculate whether costs are greater or less than

revenue (is the business profitable)

Why do managers need to be aware of the costs of all aspects of their business?

They need to know the costs of production to assess whether it is profitable to supply the market at the current price.

They need to know actual costs to allow comparisons with their forecasted (or budgeted) costs of production. This will allow them to make judgements concerning the cost efficiency of various parts of their enterprise.

They also need to know if they have sufficient finance to afford the expected costs.

Revenue defined

Revenue is the income generated by the business through selling goods or services.

You can make revenue selling GOODSAnd SERVICESSometimes called Turnover

Revenue defined

Revenue is the income generated by the business through selling goods or services.

Can be CASH (customers pay when they make a purchase; or

CREDIT (allowing the buyer some time to pay)

Risk with Credit

With selling some goods by credit the seller must watch for:

Running Short of money – in the bank (because suppliers have demand payment before customers pay)

Bad debts – these are debts that remain unpaid (carry out credit checks!)

Planning

At the start of each year most firms plan the management of their finances.

The starting point is an assessment of the income or revenue they are likely to receive during the coming financial year.

Formula:Sales revenue = Volume of goods sold x

Average selling price.

Expensive!

Some companies have a high selling price even though it may reduce sales.

These companies (often fashion or technology) believe this approach results in higher revenue or profit.

Customers must be willing to pay a high price! & no direct competition

Cheap!

Alternatively – A low price, high sales!Best when selling goods that are similar

and customers show no preference to brand.

Beware!

If you increase the price, your demand may decrease!

Question:

Answers:

Summary

Revenue is the income made by a business Business can trade in cash and revenue Revenue can be of different types – Goods and services Which types of revenue do these business make: An estate agent BT A bank A supermarket Retail A doctor

Profit

That is: PROFIT = Total revenue – Total costs.

So they key to making profit is how much the business managers to produce (and at what cost), compared to how much the business manages to sell (and at what price)

Comparing figures

Being able to classify costs into fixed, variable and total costs and measuring these against the revenue generated at different levels os selling price and quantity means business are able to discover some very valuable information:

How much should they charge? How many do they have to sell to cover their costs and avoid

losing money? How many do they have to sell to make profit? At the forecast of demand can they make profit? If things change, how much can they afford to drop the selling

price by, or let costs rise to still make profit.

Why do managers need to be aware of the costs of all aspects of their business?

They need to know the costs of production to assess whether it is ****** to supply the market at the current price.

They need to know actual costs to allow ******** with their forecasted (or budgeted) costs of production. This will allow them to make ******** concerning the cost efficiency of various parts of their enterprise.

They also need to know if they have ******** finance to afford the expected costs.

Why do managers need to be aware of the costs of all aspects of their business?

They need to know the costs of production to assess whether it is profitable to supply the market at the current price.

They need to know actual costs to allow comparisons with their forecasted (or budgeted) costs of production. This will allow them to make judgements concerning the cost efficiency of various parts of their enterprise.

They also need to know if they have sufficient finance to afford the expected costs.

Contribution to fixed costs

Explain and calculate the contribution to fixed costs.

I will cover this in the Break even section.

HL - Only

Cost and profit centres

Explain the nature of cost and profit centres.Analyse the value of cost and profit centres.

Contribution analysis for multi-product firms

Analyse the role of contribution analysis in determining the viability of each product for a multi-product firm.

Research & Discus

Pg 328 - 332