Cost, scale of production
and breakeven analysis
Chapter 19
Business Cost
Definition: Something of value to be sacrificed
Fixed Cost: Cost that doesn't change no matter how much sale the company makes,
unless changes are made on them
Ex: rent, salary
Variable cost: May increase/decrease, in relations with total items sold or produced
Ex: material cost, hourly wages, utilities
Total Cost = Fixed Cost + Variable Cost OR Average Cost per Unit x Total Units
produced
Average Cost per Unit =Total cost of production ÷ total units produced
Activity 19.3 (pdf pg 604)
How to use cost data
Setting Prices: By knowing AC, businesses know the minimum prices
to charge
When deciding whether to stop/ continue production: If it’s not
profitable, company can choose whether to stop production
Deciding on location: Different location charges different rental or
different price
Types of Economies of Scale
1. Purchasing Economies
● When business buys material in large quantity, supplier benefits form EoS;
therefore being able to provide a bigger discount.
● Gives company an advantage over competitor
1. Marketing Economies
● A bigger company means it has more money to market its products; such
as being able to use own delivery service (Lazada), or mass advertising
Types of Economies of Scale
3. Financial Economies
●
Being a bigger company makes banks trust them more to lend
them money and because of a larger loan, usually lower interest
rate is charged ($50 000 x 3%= $1500 vs $ 500 000 x 1% =
$5000)
4. Managerial Economies
●
Larger companies can afford to pay specialist managers to be
more efficient vs smaller companies where 1 manager may take
up many different roles
5. Technical Economies
●
Size of company affects the best system of production for them.
(Job vs Flow production). Sometimes due to lack of demand/
customers
Note: Larger companies
have higher total cost,
BUT lower average cost
per unit
Diseconomies of Scale
1. Poor Communication: More difficult and slower to send/ receive accurate
messages. May lead to big errors
1. Lack of commitment from employees: Lack of relationship with one
another in a large company, resulting to lack of commitment and low
efficiency
1. Weak Coordination: Big companies take longer to make decisions due to
many layers of management. Own agenda may delay delivery of message
and task
Break-even charts: comparing costs with revenue
Break-even level of output: minimum level
of output that must be sold to cover ALL
cost
-
Profit is $0 at break- even point, and
loss is $0
Formula: Fixed cost ÷ contribution per unit
(Selling price - VC)
Advantages of break- even charts
1. Easily identify expected profit or loss at output
level
2. Easily compare effect of increasing or
decreasing price
3. Easily estimate profit at maximum sale
4. Able to identify margin of safety (difference
between sales and breakeven point)
Limitations of break-even charts
1. It assumes that all goods are actually sold. Different possibilities are not
keep into factor, such as damage, leftover inventories, etc
2. Fixed cost only remain constant IF scale of production does not change (
rental increase, bigger machines, etc)
3. Focuses a lot only on break-even points, but in reality, there’s other aspects
of operations such as how to reduce waste, how to increase sales,
competitors, trends and seasons, etc
4. Assumes that costs and sales can be drawn with straight lines (Overtime
pay? Electricity bill? Discounts?
Identify:
a) Break-even point
b) Level of profit at maximum output (selling price x output) - FC - Total VC