Financial terms/calculations

• What is a cost in business?

  Anything a business has to pay for
• Why do businesses have costs?

  They need to pay for operations regularly
• What are the three main categories of costs?

  • Fixed costs
  • Variable costs
  • Total costs
• What are fixed costs?

  Costs that do not change with output
• How long are fixed costs usually fixed?

  For at least a year
• What are variable costs?

  Costs that change with business output
• What happens to variable costs when production increases?

  They generally rise
• What are total costs?

  Sum of fixed and variable costs
• How do you calculate total costs?

  Total costs = fixed costs + variable costs
• If fixed costs are £18,500 and variable costs are £9,250, what are total costs?

  £27,750
• What is revenue in business?

  Money made from selling products/services
• Why do businesses need revenue?

  To maintain operations and pay costs
• How is revenue calculated?

  Revenue = selling price x quantity sold
• If a florist sold 482 bouquets for £10 each, what is their revenue?

  £4,820
• If a web designer charges £256 for a website and designs 25 websites, what is their revenue?

  £6,400
• What is profit in business?

  Revenue left after all costs are paid
• How is profit calculated?

  Profit = revenue - total costs
• What does a negative profit indicate?

  A loss has occurred for the business
• If a business has revenue of £50,000 and total costs of £41,000, what is their profit?

  £9,000
• If a business has revenue of £30,000 and total costs of £45,000, what is their loss?

  £15,000
• What is the average rate of return (ARR)?

  Comparison of profitability of investments
• Why is the average rate of return useful?

  It helps compare different investment options
• How is average annual profit calculated?

  Average annual profit = total profit / number of years
• How is average rate of return calculated?

  ARR = (average annual profit / cost of investment) x 100
• If a business has total additional profit of £50,000 and cost of investment of £40,000, what is the ARR?

  25%
• If a business has total additional profit of £28,000 and cost of investment of £25,000, what is the ARR?

  28%
• What is break-even analysis?

  • Point where revenue equals total costs
  • Indicates no profit or loss
  • Helps determine necessary sales for profitability
• What does break-even level of output inform a business?

  Amount of products needed to sell for BEP
• What are the advantages of break-even analysis?

  • Shows necessary sales for profit
  • Assesses product viability
  • Displays revenue at each output level
  • Identifies cost reduction needs
  • Persuades investors for financing
  • Quick and easy to analyze
• What are the drawbacks of break-even analysis?

  • Assumes all stock sells at same price
  • Potential for unrealistic calculations
  • Variable costs may change
  • Time-consuming to create
• What does a break-even graph display?

  • Revenue and total costs
  • Number of products sold
  • Break-even point
• How is loss represented on a break-even graph?

  Below the break-even point
• How is profit represented on a break-even graph?

  Above the break-even point
• What does the fixed costs line represent on a break-even graph?

  Costs remain the same at any output level
• Where does the total costs line start on a break-even graph?

  On top of the fixed costs line
• How does the revenue line behave on a break-even graph?

  It rises with the level of output
• What is the margin of safety?

  • Amount sales can fall before BEP
  • Indicates profit above break-even point
  • Larger margin means lower risk
• How is margin of safety calculated?

  Margin of safety = actual sales - break-even sales
• If a business has a break-even point of 100 products and sells 150, what is the margin of safety?

  50 products
• If the break-even point is 3,800 items and projected sales are 4,000 items, how many items are profitably sold?

  200 items