Sales, Revenues and costs

• Sales

  How many products or services a business sells to its customers
• Revenue

  The stream of income that is generated by the sale of goods and services
• Costs

  Payments that a business makes in order to produce goods and services

  e.g. rent, power, raw materials
• Profit

  Difference between the value of the total sales revenue of a business and the total costs in producing that output

  TR-TC
• Sales volume


  Amount of a product is sold to customers

  Sales volume = sales revenue / unit price

  Sales revenue = selling price x sales volume
• Total Costs (TC)


  All the costs involved in producing a good or a service
• Fixed Costs (FC)


  Costs that do not change with output - it does not matter if the business is working at full capacity or if it is producing nothing

  e.g. rent, loan repayments
• Variable costs (VC)


  Costs that do change with output - if a business produces more, these costs will increase, if a business is not producing anything then the variable costs will be zero

  e.g. raw materials, packaging, energy bills
• Semi-variable costs

  1. It does not matter whether the business is busy or not, their salaries will stay the same (FC)
  2. If the business is busy they will use more labour and if they are not needed due to quietness, they will not use any (VC)
  3. Workers are payed permanently but then asked to work overtime or the opposite can be true (semi-fixed or semi-variable)
• Total Cost (TC) = Total Fixed Costs (TFC) + Total Variable Costs (TVC)
• Average Variable Cost (AVC) = Total Variable Costs (TVC) / Output (Q)
• Average Fixed Cost (AFC) = Total Fixed Cost (TVC) / Output (Q)
• Average Total Cost (AC) = Total Costs (TC) / Output (Q)
• Break-even point (BEP)


  Level of output at which the Total Revenue is exactly the same as the Total Costs TR=TC

  ABOVE the BEP = Profit

  BELOW the BEP = Loss
• Contribution 


  Selling price (P) - Variable Cost per unit (AVC)

  By subtracting the AVC from the unit price the direct costs of producing that one item are paid off. The rest goes toward paying off the fixed costs.
• BEP = FC / Contribution
• Margin of Safety

  Difference between the actual level of output and the break-even level of output. The greater the margin of safety, the better position the business is in
• Break-even charts

  When the TR line crosses with the TC line a BEP is reached

  Under the intersection = loss

  Above the intersection = profit
• Limitations of break-even analysis

  • Unpredictable events can occur and the further ahead the projections are made, the more unreliable they become
  • The model is based on assumptions about future events that are not always realistic - variable costs rise steadily but they may not due to economies of scale can reduce the price per unit, output will be sold at a given price which might not be the case due to changes in customer reactions and what competitors do
  • May not be able to sell enough to reach BEP
  • Markets are dynamic so something may happen that spoils all calculations
• Strengths of break-even analysis

  • Helps to assess the strength of a business idea
  • Helps to assess the levels of output that need to be reached to make profit
  • Shows the impact of changes in price
  • Enables the calculation of profit/loss over different levels of output
  • Helps support an application for finance
• Direct Costs


  Costs that arise specifically from the production of a product or the provision of a service

  e.g. materials, direct labour
• Overheads


  costs that are not directly related to production

  e.g. receptionist
• Sales revenue 


  total amount of money made by a business in a trading year
• Cost of sales (usually VC)


  Direct costs involved in making the sales revenue

  e.g. labour, raw materials
• Expenses (usually FC)


  Costs not directly involved in the production process e.g. wages
• Gross Profit 


  Sales Revenue - Cost of sales
• Net Profit(profit that owners retain to reinvest)


  Gross Profit - Expenses
• Retained profit


  Companies use net profit to pay their taxes and dividends and after are left with their retained profit
• Ways to increase profit

  • Increase sales revenue - increase the quantity of goods and services sold or increase the selling price of goods
  • Reduce direct costs (VC) - Reduce cost of labour or raw materials, seek discounts on bulk buy
  • Reduce indirect costs (FC) - Reduce expenses and gain a greater net profit
• Each strategy to increase profit has negative consequences

  Increase price - decrease customers

  Decrease cost of raw materials - decrease in quality

  Decrease wages - decrease motivation - decrease in performance