•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 CostsFixed 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 CostsVariable 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 CostsSemi-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

PracticeClassify the following costs for an airline as fixed, variable or semi-variable:

• Onboard drinks• Advertising & promotions• Airport fees• Fuel• Pilots’ salaries

Types of CostsDirect 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 CostsIndirect 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

PracticeClassify 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

RevenueProceeds 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 ExampleIf 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

RevenueOther 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

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