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Chapter 6 – Business Costs & RevenueSyllabus Unit – Business Finance and Accounting
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You will learn ……Why businesses need to know
the costs of running their activities and the revenue gained by selling their products
The different types of costs involved in running a business
How break-even analysis helps managers make decisions
The purpose of budgets and financial forecasts
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Business CostsWhy do we need
to know business costs?◦Comparing Costs &
Revenue◦Determining
Profit/Loss◦Comparing
locations of a possible new site
◦Price Determination
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Business CostsList 10 costs that would be
involved in opening and running a new factory making sport shoes
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Business CostsFixed Costs (FC)
◦Do not vary with output in the short-term
◦Paid regardless of output
◦“Overhead Costs”
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Business CostsVariable Costs
(VC)
◦Vary with output
◦Costs directly associated with output
◦“Direct Costs
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Business CostsTotal Costs (TC)
◦Fixed Costs +
Variable Costs
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Break-EvenThe Break-even point (BEP) is
the point at which cost or expenses and revenue are equal: there is no net loss or gain
Break-even charts show;◦Costs◦Revenue
Price x Quantity (P x Q)
◦Level of sales to breakeven
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Break-even
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Break-Even Charts
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Break-even Charts
Namib Tyres Ltd produce motorcycle tyres. The following information about the business has been obtained◦Fixed Costs are $30,000 per
year◦Variable Costs are $5 per unit◦Each tyre is sold for $10◦Maximum output is 10,000
tyres per year
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Break-even ChartsAdvantages
◦Identify break-even point of production
◦Calculate maximum profit◦Expected profit/loss at
different levels of output◦Impacts on BEP with
various business decisions◦Helps in decision-making◦Margin of Safety
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Break-even ChartsDisadvantages
◦Assumes all goods produced are sold
◦Fixed costs constant only if scale of production doesn’t change
◦Ignores other aspects of the business which need to be analysed
◦Straight lines not realistic
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Break-Even EquationBreakeven Equation
Total Fixed Costs Contribution Per Unit
Contribution◦Selling Price – Variable Cost
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Break-Even EquationA fast food restaurant sells meals for $6
each. The variable costs of preparing and serving each meal are $2. The monthly fixed costs amount to $3600
a) How many meals must be sold each month for the restaurant to break-even?
b) If the restaurant sold 1500 meals in one month, what was the profit made in that month?
c) If the cost of the food ingredients rose by $1 per meal, What would be the new break-even level of production?
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More Business CostsDirect Costs
◦Directly identified with each unit of production
◦Vary with the level of output
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More Business CostsIndirect Costs
◦Not identified with each unit of production
◦Associated with performing a range of tasks or producing a range of products
◦Overheads
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More Business CostsMarginal Costs
◦Additional costs for producing one more unit of product
◦Extra variable costs will be needed for that one extra unit
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More Business CostsAverage Cost Per Unit
Total Costs Output
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Economies of ScalePurchasing Economies
◦Bulk-buying discounts
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Economies of ScaleMarketing Economies
◦Transport◦Advertising
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Economies of ScaleFinancial Economies
◦Lower interest rates
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Economies of ScaleManagerial Economies
◦Specialists in all departments
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Economies of ScaleTechnical Economies
◦Specialisation◦Latest equipment
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Diseconomies of ScalePoor Communication
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Diseconomies of ScaleSlower Decision-Making
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Diseconomies of ScaleLow Moral
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Budgets & ForecastsBudgets
◦Plans for the future containing numerical or financial targets
Forecasts◦Are predictions of the
future
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Reasons why businesses fail
Do not consider future at all and make no plans
Unprepared for unforeseen events
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Budgets & ForecastsManagers try to
predict/forecast
◦Sales / Customer Demand
◦Exchange rates of the currency
◦Wage rises
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Budgets & ForecastsA managers biggest problem is
…….uncertainty about the future
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Forecasting MethodsTrend
◦An underlying movement or direction of data overtime
◦This can be extended into the future
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Forecasting MethodsLine of Best Fit
◦Figures plotted on graph (scatter diagram)
◦Line extended into the future
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Forecasting MethodsPanel Consensus
◦A panel of experts are asked for their opinions
◦Most likely to be on future sales
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Forecasting MethodsMarket Research Surveys
◦Useful in forecasting sales that are yet to be launched onto the market
◦No previous data exists
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BudgetsPlans for the future containing
numerical and financial targets
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BudgetsBusinesses plan months/years
aheadPlan ahead for future reactionsFuture targets in
numerical/financial terms
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BudgetsBudgets are set for;
◦Revenues◦Costs◦Production Levels◦Raw Material
Requirements◦Labour Hours Needed◦Cash Flow
Master budget is derived from these smaller budgets
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Budget and Forecasts
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BudgetsAdvantages
◦Departmental Target Setting◦Gives focus ◦Motivates◦Variance Analysis◦Worker, Supervisor & Manager
involvement◦Helps to control the business
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Budgets
Reviewing past activities
Comparing actual with budgeted
figures
Budgeting useful for:
Controlling current business activity –Keeping to Targets
Planning for the Future
Setting Goals to be achieved