The basics
Businesses must make a profit to survive
To make a profit, income ( revenue ) must be high than cost
Classification of cost
There are two type of costs:
Variable costs increase time an extra product is made
Fixed costs have to be paid even if no products are made
Variable costs : are costs that directly vary with the output produced or sold
Change in proportion to amount of output produced
Raw materials
Workers wages
Energy / fuel for machines
Fixed costs : are costs that do not vary with output produce or sold in the short run. They are incurred even when the output is 0 and will remain the same in the short run.. Also known as overhead costs.
Remain same, no matter how much businesses produces in short run
Rent
Salaries of head office workers
Heating and lighting
Insurance
Total cost = Variable cost + Fixed cost
Average cost = Total cost / Total output
Economies of scale: are factors that lead to a reduction in average costs as a business increases in size
Purchasing economies :
- Large firms are likely to get better discounts when buying raw materials than smaller firms
Marketing economies :
- The cost of advertising can be spread over more product units sold than in a small firm
- They can transport much bigger loads than smaller firms at little extra cost
Financial economies:
- Larger firms find it cheaper and easier to raise money
Managerial economies:
- Large firms can afford specialist managers which increase efficiency
Technical economies:
- Larger machinery is often more efficient
- Division of labour enables workers to specialise
Risk-bearing:
- Bigger companies can spread their risk by investing in more products and more markets
Diseconomies of scale: very large businesses may become less efficient than smaller ones leading to increased unit costs
Decision-making:
- A large hierarchy and bureaucracy can slow down decision-making leading to missed opportunities
Communication:
- Top managers may be so focused on strategy that they become separated from the firm's employees, products and customers, lead to morale
Diversification:
- The firm may try to do too many things at once which it might loses sight of its objectives and may need to emerge to refocus
Geographical:
- Head office and branched may lose touch and pull in different direction
Break even analysis : tells a business what it needs to sell to cover its costs
The Break-even Point
Variable + fixed costs = total costs
Total revenue = Quantity sold x price
total costs = sells revenue
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).
BEF formular :
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)
BEF graph :
Benefits of BEF graph:
Show the expected loss and profit
Show the break even output
Show the margin of safety
Help in decision making
Drawbacks of break even charts
‘Straight line’ assumption
Fixed costs not always constant
Only concentrate on the break even point
Assumes that all goods produced are sold
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