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Costs

The document explains the concepts of fixed and variable costs, detailing how total costs are calculated and their implications for business decisions such as pricing and production. It introduces the break-even point, where total revenue equals total costs, and illustrates how to calculate it using a chart and formulas. Additionally, it discusses the advantages and limitations of break-even analysis in business planning.

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UPMA SHARMA
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16 views3 pages

Costs

The document explains the concepts of fixed and variable costs, detailing how total costs are calculated and their implications for business decisions such as pricing and production. It introduces the break-even point, where total revenue equals total costs, and illustrates how to calculate it using a chart and formulas. Additionally, it discusses the advantages and limitations of break-even analysis in business planning.

Uploaded by

UPMA SHARMA
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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YEAR 10 BUSINESS COST AND BREAKEVEN CHAPTERS

Costs

Fixed Costs are costs that do not vary with output produced or sold in the short run. They are incurred
even when the output is 0 and will remain the same in the short run. In the long-run they may change.
Also known as overhead costs.

E.g.: rent, even if production has not started, the firm still has to pay the rent.

Variable Costs are costs that directly vary with the output produced or sold. E.g.: material costs and
wage rates that are only paid according to the output produced.

TOTAL COST = TOTAL FIXED COSTS + TOTAL VARIABLE COSTS

TOTAL COST = AVERAGE COST * OUTPUT

AVERAGE COST (unit cost) = TOTAL COST/ TOTAL OUTPUT

A business can use these cost data to make different decisions. Some examples are: setting prices (if the
average cost of one unit is $3, then the price would be set at $4 to make a profit of $1 on each unit),
deciding whether to stop production (if the total cost exceeds the total revenue, a loss is being made,
and so the production might be stopped), deciding on the best location (locations with the cheaper costs
will be chosen) etc.

Break-even
Break-even level of output is the output that needs to be produced and sold
in order to start making a profit. So, the break-even output is the output
at which total revenue equals total costs (neither a profit nor loss is
made, all costs are covered).
A break-even chart can be drawn, that shows the costs and revenues of a
business across different levels of output and the output needed to break
even.

Example:
In the chart below, costs and revenues are being calculated over the output
of 2000 units.
The fixed costs is 5000 across all output (since it is fixed!).
The variable cost is $3 per unit so will be $0 at output is 0 and $6000 at
output 2000- so you just draw a straight line from $0 to $6000.
The total costs will then start from the point where fixed cost starts and be
parallel to the variable costs (since T.C.= F.C.+V.C. You can manually
calculate the total cost at output 2000: ($6000+$5000=$11000).
The price per unit is $8 so the total revenue is $16000 at output 2000.
Now the break-even point can be calculated at the point where total
revenue and total cost equals– at an output of 1000. (In order to find the
sales revenue at output 1000, just do $8*1000= $8000. The business needs
to make $8000 in sales revenue to start making a profit).

Advantages of break-even charts:


 Managers can look at the graph to find out the profit or loss at each
level of output
 Managers can change the costs and revenues and redraw the graph to
see how that would affect profit and loss, for example, if the selling
price is increased or variable cost is reduced.
 The break-even chart can also help calculate the safety margin- the
amount by which sales exceed break-even point. In the above graph, if
the business decided to sell 2000 units, their margin of safety would be
1000 units. In sales terms, the margin of safety would be 1000*8 =
$8000. They are $8000 safe from making a loss.
Margin of Safety (units) = Units being produced and sold –
Break-even output
Limitations of break-even charts:
 They are constructed assuming that all units being produced are
sold. In practice, there are always inventory of finished goods. Not
everything produced is sold off.
 Fixed costs may not always be fixed if the scale of production
changes. If more output is to be produced, an additional factory or
machinery may be needed that increases fixed costs.
 Break-even charts assume that costs can always be drawn using
straight lines. Costs may increase or decrease due to various
reasons. If more output is produced, workers may be given an
overtime wage that increases the variable cost per unit and cause the
variable cost line to steep upwards.

Break-even can also be calculated without drawing a chart. A formula can be


used:

Break-even level of production =Total fixed costs/ Contribution per


unit
Contribution = Selling price – Variable cost per unit (this is the value
added/contributed to the product when sold)
In the above example, the contribution is $8 -$3 =$5, so the break-even
level is:
$5000/$5 = 1000 units!

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