5.3 Revenue, Costs and Profit

• Fixed costs


  • Costs that do not change as the level of output changes
  • Have to be paid, even if a business does not produce any output
  • e.g. rent, management salaries, insurance and bank loan repayments
• Variable costs 


  • Directly linked to output - Increase as output increases, and vice versa
  • e.g. raw material costs and the wages of workers directly involved in production and packaging
• Total costs 


  • The sum of the fixed and variable costs at a particular level of output

  [ TOTAL COSTS = TOTAL VARIABLE COSTS + TOTAL FIXED COSTS ]
• Diagram: Costs

  A) TOTAL COSTS

  B) VARIABLE COSTS

  C) FIXED COSTS

  
• Ways to reduce costs :


  • Reduce fixed costs
  • Reduce staffing levels
  • Replace insufficient fixed assets
  • Relocate the business
  • Reduce variable costs
  • Seek new suppliers
  • Purchase in bulk
  • Buy cheaper stock
  • Change packaging
  • Reduce one-off costs & interest
  • Restructure borrowing
  • Lease fixed assets
  • Delay purchases
• Revenue


  • Value of items sold by a business over a period of time

  [ REVENUE = SELLING PRICE x QUANTITY SOLD ]
• Ways to increase revenue



  • Sell more items
  • Selling more items can lead to an increase in revenue, as long as the selling price is not reduced
  • Raise the selling price
  • Raising prices can lead to increased revenue, as long as it has a minimal effect on the volume of items sold
  • If products have few rivals or are essential, a price rise is likely to lead to greater revenue
  • However, higher prices may repel customers
• Profit 


  • The surplus that remains after business costs have been subtracted
• Gross Profit 


  • The difference between revenue and the costs directly related to production

  [GROSS PROFIT = REVENUE - COST OF SALES ]
• Net profit 


  • The difference between gross profit and the indirect expenses of the business

  [ NET PROFIT = GROSS PROFIT - EXPENSES ]
• Gross profit margin


  • The proportion of revenue that is converted into gross profit

  [ $GROSS\ PROFIT\ MARGIN\ =$$\ \frac{GROSS\ PROFIT}{REVENUE}\times100$ ]
• Net profit margin


  • The proportion of revenue that is converted into net profit

  [ $NET\ PROFIT\ MARGIN\ =$$\ \frac{NET\ PROFIT}{REVENUE}\times100$ ]
• Average Rate of Return (ARR)


  • Helps a business judge whether an investment will be worthwhile
  • It compares the initial cost of an investment with the average profit likely to be generated each year