Costs

Costs of Production

Businesses calculate the cost of production

For forecasting and budgeting
To set prices so they make a profit
To work out if they can make a profit

Costs

Fixed costs

These do not alter with output
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

Alter directly with the business’s level of output
Examples – fuel, raw materials
Graphically variable costs will always be a diagonal line from the origin
As output changes variable alter directly

Total costs

These are fixed and variable costs added together

Semi variable

These have a fixed and a variable element

Direct Costs

Attributed to the production of a particular product and vary directly with output e.g direct materials and labour

Indirect Costs

Can't be allocated to the production of a specific product and relate to the business as a whole e.g. indirect labour costs, administration

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 = zero.

Businesses must make a profit to survive. To make a profit, revenue must be higher than costs.

Break even analysis can use a number of methods:

Contribution method
Break even chart
Break even graph

Calculating the break-even point (contribution method)

Breakeven Point = Fixed Costs / (Selling Price - Fixed Costs per Unit)

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.

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