Accounting Costs, Profit, Contribution and break Even Analysis
Content • Costs • Fixed / variable • Direct / indirect • Revenue • Profit • Contribution • Break Even Analysis
Costs • Fixed costs – these do not alter with output • Variable costs – alter directly with the business’s level of output • Total costs – are fixed and variable costs added together • Semi variable – have a fixed and a variable element
Fixed Costs • Examples – rent, management salaries, rates • Graphically fixed costs will always be illustrated by a horizontal line • As output changes fixed costs stay the same
Variable costs • Examples – fuel, raw materials • Graphically variable costs will always be a diagonal line from the origin • As output changes variable alter directly
Direct / Indirect Costs • Direct – are attributed to the production of a particular product and vary directly with output e.g direct materials and labour • Indirect – Cant be allocated to the production of a specific product and relate to the business as a whole e.g. indirect labour costs, administration
Why do businesses calculate costs of production? • For forecasting and budgeting • To set prices so they make a profit • To work out if they can make a profit
Revenue • Revenue = Quantity Sold x Average Selling Price • Generally if it reduces its selling price you expect to sell more • A rise in price usually leads to a fall in quantity sold
Profits • Profit = Total Revenue – Total Costs • Profit depends on: • Profit margins – the amount or % of the final selling price that is profit • Quantity or volume sold • Total costs • Profit is the main objective of firms in the private sector
Contribution • Contribution is the total revenue – variable costs • It measures how much is being contributed the fixed costs by the units that have been sold • Contribution per unit = Selling price per unit – Variable cost per unit
Break even Analysis • A business breaks even if it does not make a profit or a loss • It is the point at which the business makes just enough revenue to cover their costs. • In other words profit = 0 • Businesses must make a profit to survive. • To make a profit, revenue must be higher than costs.
Break even methods • Break even analysis can use a number of methods: • Contribution method • Break even chart • Break even graph
The Contribution Method This involves a two part calculation: • Selling Price per unit – variable cost per unit = contribution (towards fixed costs). AND • Fixed costs divided by contribution = Break even point.
Profit or Loss LOSS TC > TR
Summary • Costs can be classified into fixed (don’t change with output) and variable (change with output) • Direct costs are costs directly related to the costs of producing an item, indirect costs are not directly related • Revenue – sales revenue x quantity • Profit = Total costs – Total revenue • Profit is the number one objective of most firms in the private sector • Contribution – Selling price – variable cost, it looks at how much each unit is contributing to fixed costs • Break Even Analysis – where a business makes neither a profit or a loss • Break even equation = Fixed costs / contribution per unit