Calculating Costs,
Revenues and Profit
Today’s session

Identification of fundamental business cost elements

Distinguishing between revenue and profit

Calculating costs and revenue at different levels of output

Calculating profit or loss
Calculating costs
Why businesses need accurate and reliable cost information
Defining Costs

QUESTION – WHY do businesses need to define potential COSTS?

ANSWER – to enable them to make informed business decisions in order
to remain profitable

Identifies likely BUSINESS VIABILITY e.g enables the business to forecast
actual profit or loss that will be made

Allows the business to make PRICING DECISIONS

A PROFIT SURPLUS can provide a source of finance for further expansion
ACTIVITY – using the whiteboard, list as
many costs as you can think of for a new
business – we will come back to these
costs later...
Opportunity Cost
What is the definition of OPPORTUNITY
COST – write the answer on your
whiteboard
Opportunity Cost = the cost of the
next best alternative forgone.
The value that could have been earned if a resource was
employed in its next best use. e.g. if spend £40k on
advertising campaign it could have been earning interest
in a bank account.
Accounting Costs
Accounting Cost = the value of an
economic resource used up in production

Accounting costs are recorded in the business accounts as an ASSET or as
an EXPENSE
Jot down an example of an ASSET and an EXPENSE in your
notes
Changing costs – Short and Long Run

Costs can change over a period of time as a business grows and develops

SHORT RUN


At least one factor of production is fixed e.g. Amount of space, available
machinery
LONG RUN

All factors may vary. Capacity may be increased but when saturation is reached
another SHORT RUN period will begin.
Types of Cost

Costs can be

FIXED


VARIABLE


Costs of production that increase directly as output rises
SEMI-VARIABLE


The same at all levels of output in the short run
Costs that consist of a fixed value + a variant value which can increase dependent on
usage
TOTAL COSTS are all the fixed and variable costs added together –
TC
= FC + VC
Jot down an example of a FIXED COST, a VARIABLE COSTS
and a SEMI-VARIABLE COST in your notes. Compare your
Fixed Costs

Diagram shows that even as output increases fixed costs stay the same. It’s a
short run scenario usually.
Stepped Fixed Costs

This can occur over a longer period of time following for example an
investment in new machinery.
Variable Costs

Diagram shows that as output increases the variable costs increase.
Total Costs

As output increases fixed costs become smaller part of total costs
ACTIVITY – 3 minutes
Calculate the fixed, variable and total costs
for trading at Sycks Buckets
Fixed costs £000
Variable costs £000
100
140
750
364
TOTAL COSTS £000
640
1000
How did you do...
Calculate the fixed, variable and total costs
for trading at Sycks Buckets
Fixed costs £000
Variable costs £000
TOTAL COSTS £000
100
40
140
250
750
1000
364
640
1004
Activity

Using the list on the board and working in pairs, identify which costs are
FIXED, VARIABLE and SEMI-VARIABLE

Compare your answers to the next pair – do they match?
More on costs...

Costs can be


DIRECT

identified to a specific product

Usually VARIABLE
INDIRECT

accrued across the business

Usually FIXED

Also known as OVERHEADS
Identify which are DIRECT and which are
INDIRECT costs at Sycks Buckets
Rent
Factory
heating
Bucket
rivets
Bucket
Catering Telephon
moulds
e
Business Packaging Bucket
loan
handles
Productio Accounts Bucket
n labour
staff
sales
team
How did you do?
Rent
Factory
heating
Bucket
rivets
KEY:DIRECT
INDIRECT
Bucket
Catering Telephon
moulds
e
Business Packaging Bucket
loan
handles
Productio Accounts Bucket
n labour
staff
sales
team
Activity

Using the list on the board and working in pairs, identify which costs are
DIRECT and INDIRECT

Compare your answers to the next pair – do they match?
Yet more on costs..

AVERAGE COST (UNIT COST)

Cost per unit of production

Calculation:-
Average cost =
Total cost
Output
QUESTION – What does the TOTAL COST figure consist of?
ANSWER – FIXED COSTS + VARIABLE COSTS
FC
+
VC
AC=
Output
You can also calculate average costs for...

AVERAGE FIXED COST

Calculation:-
Average fixed cost = Total fixed cost
Output
AFC= FC
Output
£ AVERAGE VARIABLE COST
€ Calculation:VC
Average variable cost =Total variable cost AVC=
Output
Output
Calculate the average costs
Output
Fixed
Cost
Average
fixed
cost
Variable
Cost
100
100
150
200
100
300
300
100
450
400
100
600
Average
variable
cost
Total
Cost
Average
cost
Average cost calculations
Output
Fixed
Cost
Average
fixed
cost
Variable
Cost
Average
variable
cost
Total
Cost
Average
cost
100
100
1.00
150
1.50
250
2.50
200
100
.50
300
1.50
400
2.00
300
100
.33
450
1.50
550
1.83
400
100
.25
600
1.50
700
1.75
Marginal cost

Marginal cost is the cost of increasing total output by one more unit
Marginal cost =
Output
100
Fixed
Cost
100
Change in Total Cost
Change in Output
Variable
Cost
150
Total
Cost
250
Change
in
output
101
MC= CITC
CIO
Change
in total
cost
Marginal
cost
252.50
2.50
COSTS Checkpoint – what you can
remember??

Working in your teams, match the COSTS to the DEFINITIONS

First group to complete the puzzle wins the prize and gets the points

In the event of a draw, there will be a finance tie-breaker...
Cost classification – the theory...

By TYPE, i.e. Analysing business costs to identify if they are


By BEHAVIOUR i.e. the effect a change in output levels has on costs


Production, selling, administration, HR
By the NATURE of the resource i.e. Classifying according to resource
acquired


Fixed, variable, semi-variable, average, marginal
By FUNCTION i.e. The business function they are associated with


Direct or indirect
Materials, labour, expenses
By PRODUCT, CUSTOMER or CONTRACT
Cost classification – the reality...

Cost classification not always straightforward

Difficulties in options for cost classification dependent on nature of cost
e.g.


Piece rate – direct or variable

Administrator salary – fixed or indirect
Challenges of allocating indirect costs to each product
Classification often depends on classification
purpose as well as management viewpoint
Total Revenue

Total revenue is the amount of money received from selling a product
Total Revenue= Quantity Sold x Price TR= QS x P
£000
Total Revenue
Output (000)
Q- What is the total revenue for 500 products sold at £5 each?
A- 500 x £5 = £2500
Profit and Loss



PROFIT is the difference between REVENUE and COSTS
Revenue EXCEEDS Costs = PROFIT
Costs EXCEED Revenue = LOSS
Q - If Sycks Buckets have a monthly revenue of
£30,000 for and costs of £26,400 how much profit
have they made?
A - £30,000 - £26,400 = £3,600
Q - If costs increase by 15% and revenue remains
static, how much profit have they made now?
A - £30,000 - £30,360 = (£360) LOSS
Profit

1.
2.
3.
4.
Profit is a surplus. It is important for 4 reasons:
Used as a measure of success by the owners of a
business who have invested capital into it.
Banks/other lenders may be unwilling to lend to
businesses making a loss or not forecasting a
profit.
It is the return/reward for the entrepreneurs
risk taking
Can provide a source of finance for the business.
Why calculate costs?

To help forecast profit/loss

To forecast breakeven point

For financial planning

For pricing decisions

To keep check of actual costs against projected ones
Today’s session

Identification of fundamental business cost elements

Distinguishing between revenue and profit

Calculating costs and revenue at different levels of output

Calculating profit or loss
Any Questions??
Next session contribution