5.2 Costs and Revenues

Chapter 31

Management Decisions and Cost Business decisions cannot be made without

cost information. Why? Profit or loss cannot be calculated without

knowing COST Marketing will use COST information to determine

pricing COST records are useful in comparing to past

performance and help set budgets COST data can help determine the use of

resources…use labor hours or buy automated equipment?

Production Costs

The financial costs incurred in making a product or providing a service.

Costs are classified into categories: Direct Costs Indirect Costs Fixed Costs Variable Costs Semi-Variable Costs Marginal Costs

Direct Costs

Direct Costs Costs can be clearly identified with each unit of

production and can be allocated to a cost center. Direct costs of a hamburger in a fast-food restaurant is

the cost of meat…. You name another Direct cost for a automobile repair shop servicing a car

is the labor of the mechanic…You name another Direct cost for a business studies department is the

salary of the business teacher…You name another

Common direct costs in manufacturing are labor and materials. Common direct costs in a service business is the cost of goods sold.

Indirect Costs

Indirect Costs Costs which cannot be identified with a unit of

production – also known as overhead costs

Indirect cost to a farm is the purchase of a tractor…. You name another

Indirect cost to a automobile repair shop is rent…You name another

Indirect cost of running a school is the cost of cleaning…You name another

Indirect Costs

Indirect Costs can be classified into 4 groups:

1. Production overheads – factory rent, equipment depreciation, electricity

2. Selling and distribution overheads – warehouse, packing, and distribution costs

3. Administration overheads – office rent, clerical salaries

4. Finance overheads – interest on loans

Costs are affected by Output Some costs vary with output of production and some

costs do not change.Costs can be classified: Fixed costs –

These remain constant no matter what happens to production output (rent)

Variable costs –These vary as production output changes (quantity of raw materials used)

Semi-Variable costs – These include both fixed and variable costs (account charge for electricity plus the electricity used)

Marginal costs – The additional variable cost of producing one more unit

Revenue

Revenue is the income received from the sale of a product

Total Revenue is the total income from the sale of ALL units of the product (quantity X price)

Don’t confuse Revenue, Cash Flow, and Profit

Remember: Revenue is not the same as cash received from sales. Revenue is recorded at the time of sale not at the

time cash is received.

Remember: Revenue is not the same as profit. All costs of operating the business are subtracted

from revenue to determine profit.

Contribution to Fixed Costs

Contribution per UnitIs the selling price of a product less variable

costs per unit.

Total ContributionIs the total revenue from the sale of a product

less total variable costs of producing it.

Contribution is NOT profit. Contribution is what a product “contributes” towards fixed costs, and once these are paid, towards the profits of the business.