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Revenue is the money a b.receives from the sale of products to customers.A positive difference between revenues and costs will then leave the b.with a profit.

TYPES OF COSTS

FIXED COSTS (rent, insurance, equipment leases, payments on loans, depreciation, management salaries, advertising)

Are the costs of production that a b.has to pay regardless of how much it produces or sells:rent on leased premises and interest on existing bank loans will have to be paid no matter how much a firm sells or produces,advertising,market research,management salaries…these costs remain unchanged in the short run.

Fixed costs can change,but these changes happen independently of the level of output.E.g.,a property owner decides to raise rents due to higher property prices in the economy.Another example would be directors and managers being paid higher salaries due to rising costs of living.

VARIABLE COSTS (hourly production wages, sales commissions, inventory, packaging supplies, shipping costs)

Are the costs of production that change in direct proportion to the level of output or sales:raw materials,commission earned by sales staff,packaging costs…

TC=TVC+TFC

COSTS AND REVENUES

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SEMI-VARIABLE COSTS

Are those that contain an element of both fixed and variable costs.They only tend to change when production or sales exceed a certain level of output.Sales people tend to earn a fixed basic pay in addition to their commission(a variable element).Machinery and vehicles are usually classed as a fixed cost,but their maintenance and depreciation costs will increase as they are used more.

DIRECT COSTS

Are similar to variable costs in that they change with the level of output,however,without that particular project or product,the costs would not be incurred by the b.Since direct costs rely directly on output levels they are a type of variable costs but are more suitable to look at when dealing with b.that produce more than one product.

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INDIRECT COSTS(OVERHEADS)

Are those that cannot be clearly related to the level of output of any single product,i.e.they are not directly linked with the level of production or sale of a product.E.g.,the costs of fuel and power can be associated with the level of production,but may not be directly linked to a particular product but apply to several or all different areas of the b.Other examples might include:rent,advertising,legal expenses,insurance,utility bills,accounting fees..Unlike fixed costs,indirect costs are not readily identified with a particular business activity.However,most indirect costs could also be considered as being fixed costs since they do not directly relate to the level of output.

In general,the terms indirect and direct costs are used when referring to b.that produce or sell a range of products and therefore operate cost centres and profit centres.The terms fixed and variable costs,as used in break-even analysis,tend to be used when referring to the sale or production of a single type of product.

AVERAGE COST

Is calculated by dividing total costs by the level of output.Two components:AFC and AVC.

The average fixed costs of a firm will decline continuously with larger levels of output.This is because the total fixed costs remain constant but are spread over an increasing amount of output,i.e.the same(fixed)costs are being divided by a larger and larger number

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REVENUE

Sales revenue=price x quantity sold

Other sources of non-sales revenue for a b.include:

-subventions:these are subsidies offered to certain firms to help reduce their costs of produc.

-grants:these are also a form of government assistance

-donations:these are financial gifts from individuals or other org.Charities and non-profit org.tend to rely on this source of revenue

-fund-raising:org.can run special fund-raising events to help generate extra revenue.

-sponsorship:this is a form of below-the-line promotion whereby the sponsor financially supports an org.in return for a prominent display of the donor’s brand or trademark

-interest:b.can earn interest from its cash holdings at the bank

-dividends:most companies will hold shares in other b.

-sale of assets:firms can sell off their underused or idle assets for cash

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CONTRIBUTION

Refers to the amount of money that remains after all direct and variable costs have been taken away from the sales revenue of a b.

Contribution per unit=P(PRICE OR AVERAGE REVENUE)-AVC(AVERAGE VARIABLE COSTS)

E.g.,if a firm sells its chairs at $100 each whilst the direct and variable costs are $45 per chair,the b.makes a contribution of $55per chair.This is not the actual profit made because fixed and indirect costs have not yet been accounted for.However,each chair sold contributes $55 towards the payment of the firm’s overheads and fixed costs.Once these have been covered,further sales will contribute towards the profit of the b.

Profit=Total contribution- Total Fixed Costs

It is possible to see that profits can be increased:

-increasing sales of the product to help to raise the total contribution

-decreasing variable costs,perhaps through negotiating better deals from current suppliers or seeking new suppliers that are more competitive

-reducing fixed costs and overheads,perhaps through better financial control methods or the use of cost and profit centres

Contribution analysis can be useful in helping a b.to identify areas that are relatively profitable and areas that may need a little more attention

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Human resources also have a key role in helping the b.to control costs and to raise revenues.Managers must have the means to measure and assess the performance of staff,and to reward them appropriately.