COSTS

REVENUES
BREAK-EVEN ANALYSIS
AND PROFIT

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THE WORKBOOK!

NAME: ……………………………….

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 INTRODUCTION

When you look closely at many businesses (large and small) you will find they
generally share a common objective, that is, to make a profit. This allows them to do
other things such as expand their scale of production by buying new machinery or
larger premises.

However, predicting how much profit you will

make is not as easy as it sounds. You can use
accounting techniques (such as budgeting) but that
is not the only method. An important theory to
learn is that of BREAK-EVEN ANALYSIS. Not
only does this topic come up regularly in
examinations, once you have mastered it, it lets
you calculate all sorts of other important figures.

It is worth noting that several of the

formulas are dependant on the answers
gained from OTHER formulas you will
calculate. Therefore, if you get the first
answer wrong then ALL the other
answers will be wrong too! But don’t

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panic. Luckily, in the examination,
your answers will be marked using the
“own figure” rule. This means that, as
long as you use the correct method,
getting a wrong figure will only lose
you marks once rather than all the way
through the calculations. That is why it
is important to write the formula you intend to use in WORDS at the start of each
question. That way the examiner can be in no doubt that you really know what you
are doing – you just made a silly mistake with your calculator. Phew!

Another thing to note about break-even analysis is

that it generally involves drawing graphs.
Therefore when tackling any break-even question
you need to be well equipped with a sharp pencil,
a long ruler, a rubber and a calculator. There is
nothing worse to show an examiner than a
scruffily drawn graph. It should be clearly
labelled and contain all of the relevant details (but
more on that later).

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 FIXED COSTS
Let us imagine a factory. For fifty weeks a year the factory is used to produce
bicycles. However, for two weeks a year all of the employees of the factory go on
holiday at the same time and the factory is closed. No bicycles are produced.

While the employees are enjoying their vacation,

the factory is still incurring costs (or the owners
still have to pay certain costs) even though no
bicycles are being produced for them to sell.
They still have to pay rent on the factory (or their
mortgage repayments). They still have to pay the
salaries of their managers. Maybe they have a
loan to repay. They still have to meet these costs
even though they may not have any income from
sales of bicycles while the factory is closed for the
holidays.

Similarly, when the workers return from their

vacation and start producing bicycles again, the
costs mentioned above have to be met. But, it
doesn’t matter how many units of output (bicycles)
the factory produce, these costs remain the same.
So whether they make zero units or whether they

www.igcsebusiness.co.uk make the maximum number they can make at the

moment with the factors of production they are
employing (their capacity), these costs do not
change – that is – as long as a business has the
capacity to produce more units, the fixed costs do
not change as output increased or decreases.

However, once the business has reached its capacity and all of its factors of
production (land, labour and capital) are working as hard as they can (called being
fully employed), in order to produce more units of output, they must increase their
capacity. This means employing more factors of production (such as buying a bigger
factory or more machines). This will make the fixed costs increase, but, it means the
business can increase the scale of production and so benefit from “economies of
scale”.
Fixed costs – costs that do not change as output increases as long
as there is sufficient capacity to produce more units.

Full capacity – the ability to produce as many units of production

as possible from a given number of inputs.

Examples of fixed costs

 Rent  Loan repayments  Computer maintenance

 Salaries  Telephone bill  Rates

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Question 1

For the following businesses, calculate their TOTAL FIXED COSTS for the year.
(N.B. for ALL calculations in this workbook, assume a fifty week year).

BUSINESS A Results Calculations

Rent per month £300

Salaries per month £24,000

Loan repayment per month £2,700

Annual fixed costs

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BUSINESS B Results Calculations

Rent per week £75

Salaries per month £6,000

Telephone bill per quarter £250

Annual fixed costs

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 VARIABLE COSTS
We have seen how some costs stay the same even if we produce more units of output.
However, this must mean that some costs change depending on how many units of
production we make. These are variable costs.

Variable costs – costs that change as output changes.

Examples of variable costs

 Wages  Packaging
 Raw materials  Transport

We can refer to variable costs as either per unit (or average variable costs) or as total
variable costs.

Average variable costs = Total Variable Costs

Output

Total variable costs = variable costs per unit x output

Question 2

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For the following businesses calculate their total variable cost and the average
variable cost.

BUSINESS C Results Calculations

Number of employees 50

Average yearly wage £10,000

Raw materials per unit £3

Packaging per unit £1

Yearly output (units) 350,000

Total variable costs

Average variable cost

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BUSINESS D Results Calculations

Number of employees 75

Average weekly wage £350

Raw materials per unit £6

Transport per unit £0.50

Weekly output (units) 700

Total variable costs

Average variable cost

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BUSINESS E Results Calculations

Labour cost per unit £2

Raw materials per unit £4

Packaging per unit £0.50

Weekly output (units) 1,600

Total variable costs

Average variable cost

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 A FURTHER NOTE ABOUT IDENTIFYING COSTS
So now we know about fixed costs and variable costs, and we have seen some
examples of each. However, what if a question gives you a cost and you haven’t
come across it before – lets say the cost of widgets! How do you tell if it is a fixed or
variable cost?

If the question says:

Cost of widgets per year = £15,000 ………….. this will be a fixed cost.

However, if the questions says

Cost of widgets per unit = £1.50 ………….. this will be a variable cost

Therefore:

If a cost is given for a period of time = fixed

If a cost is given per unit = variable

However, there is always the exception that proves the rule. You may get costs which
you know are variable (the best example being wages) but they might be quoted per
week or per month. They are still variable costs so try not to get too confused!

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Question 3

In the following table, identify which costs you think are fixed and which are variable.

Item Fixed or Item Fixed or

variable? variable?

Rent per week Telephone bill

Maintenance on Managers salaries per

machines per annum month

Labour costs per unit Raw materials per unit

Packaging per unit Transport per unit

Mortgage payments Depreciation per

per month annum

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 TOTAL COSTS
So far we have split costs into two distinct categories – fixed and variable. We have
done this so that we can tell which costs vary as output changes (and therefore will
increase as output increases) and which costs do not change until capacity is reached.

However, now we have split them apart and analysed them, it is time to put them back
together and find the total costs.

Total cost – the entire cost of production at a given level of output.

Total costs = fixed costs + variable costs

This can be abbreviated to:

TC = FC + TVC

This is all very well when you know the total of the variable costs incurred by a
business. But what if you only know the variable cost per unit? You might end up
with the classic mistake made by many students. Here is an example:

A business has annual fixed costs of £100,000 and has variable costs per unit of £7.
Many would therefore state:

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TC = FC + TVC

= £100,000 + £7

= £100,007

Now, the ONLY time this would be correct is if the factory made 1 unit of output.
However, the likelihood of this being true is remote! What the student should have
done is:

TC = FC + (VC per unit x OUTPUT)

This way we actually find the true value of total costs. In the example used above,
let’s say the business makes 10,000 units a year. The total cost would therefore be:

TC = FC + (VC per unit x OUTPUT)

= 100,000 + (7 x 10,000)

= 100,000 + 70,000

= £170,000

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This calculation brings up another important issue when performing calculations in an
exam or test. Students LOVE to get to the exciting (?) number part of the question.
In doing this you leave yourself open to making silly mistakes. In ANY calculation in
business studies, you should use a three-stage approach.

Stage 1 - Write the formula IN WORDS

Stage 2 - Substitute in numbers and perform

any intermediate calculations i.e.
calculating the contents of brackets.

Stage 3 - CLEARLY state the answer,

remembering the correct units.

Using this approach you are maximising the number of marks you can obtain – even
if you actually get the maths wrong, you have shown the examiner that you know the
formula. In most cases, this will get you at least 1 mark.

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Question 4

Calculate the total costs for the following businesses. Show your workings out in the
spaces provided.

BUSINESS F Results Calculations

Labour cost per unit £5

Raw materials per unit £4

Rent per month £600

Weekly output (units) 3,000

Total costs

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BUSINESS G Results Calculations

Labour cost per unit £7

Raw materials per unit £12

Rent per month £800

Weekly output (units) 500

Total costs

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BUSINESS H Results Calculations

Number of employees 10

Average weekly wage £200

Raw materials per unit £9

Rent per month £750

Telephone bill per quarter £150

Weekly output (units) 2,000

Total costs

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 DIRECT AND INDIRECT COSTS
OK, so you know about fixed costs, variable costs and even total costs. Surely there
can’t be any other types? Well, yes there is – several different types in fact!

Some of the costs (like average or unit cost) are the results of calculations. However,
some are another way of classifying the costs like we did with fixed and variable.
This time however, the distinction is not dependent on output, but on whether a cost
can be directly related to the production of an item or not. These are called direct and
indirect costs.

Direct costs – a cost that can be clearly identified with a

particular unit of output

Examples of direct costs

 Raw materials
 Packaging
 Direct labour (i.e. production workers)

As you can see this is very similar to variable costs but technically they are not the
same. For instance, we would take anyone being paid a wage as being a variable
cost, but we would only take production workers as a direct cost – not cleaners for
instance.

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The opposite of direct costs are indirect costs. Another word for these is
OVERHEADS. These are costs for which it is not possible to associate them directly
with particular products.

Indirect costs – a cost that cannot be identified with a particular

unit of output. They are incurred by the whole
organisation or by a department.

Examples of indirect costs

 Rent  Salaries of office staff

 Insurance  Wages of non-production workers

As you can see these are very similar to fixed costs. It can be pretty difficult
to understand the difference between a fixed cost and an indirect cost.
Imagine how difficult it is for businesses to actually calculate them. For
example, it would be very time-consuming to relate precisely the amount of
electricity used to make one item! Also usage of some materials (such as
for cleaning and maintenance) may increase the more units we make, but it
would take too long to figure out by exactly how much. The information
gained would not be worth the time taken.

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 AVERAGE COSTS
Costs …. The story so far. We now know that there is more than one way to
classify costs. We have also analysed costs by breaking them down into
fixed and variable types and then, added them up again to find the total
costs. All of that information is useful to a business. However, there is a
piece of information that may prove to be even more useful. That is, finding
out how much ONE unit of production costs to make. This is the average or
the unit cost.

Why would this be so useful? Well,

firstly, businesses would like to know if
they are going to make a profit. If they do
not know how much one good costs them
to make, how can they set a selling price
above that cost? They may end up making
a loss without realising it.

Also, as we are about to discover, the more units we make, the lower the average cost
(this is the concept of economies of scale). However, this only works up to a point.
If we make too many units then we start to suffer from diseconomies of scale
which means the average cost starts to rise. A business will want to make
enough units to benefit the most from economies but not so many that they slip into
diseconomies and start to become inefficient.

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Average (or unit) cost = Total Costs
Output

Question 5

Using the information below, fill in the table on the next page and calculate
the average cost at each level of output

Item Cost Fixed or variable

Rent on premises £450 per week

Hire of machinery £150 per week
Heating and lighting £100 per week
Repayment of bank loan £300 per week
Materials £7 per cushion
Packaging £1 per cushion
Labour £2 per cushion

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N.B. Show all your calculations in the spaces provided.

Units made Total Fixed Total Variable

per week Total costs Average Cost
costs costs

0 ----------

100

200

300

400

500

600

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800

900

1000

Describe your results

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What you should have found is that the more units of output are produced, the lower
the average cost becomes. However, the difference between each output level
becomes smaller and smaller. For example:

The average cost at 100 units is £20 but the average cost at 200 units is £15. The
difference between the two is £5.

However ……

The average cost at 900 units is £11.11 but the average cost at 1000 units is £11. The
difference between the two is only £0.11p.

Therefore we can see that when a small amount of units is made, an increase in the
scale of production will decrease costs by a large amount. But when a large amount
of units are already being produced, an increase in the scale of production lowers
average cost by a significantly smaller amount.

If we were to plot the average costs on a graph, it has a special shape. This is known
as the average cost curve and a typical example is given below.

Average cost

60.00

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50.00
Average cost

40.00

30.00

20.00

10.00

0.00
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
units

Steep curve at start

Shallow curve at end

Question 6

Plot the average costs you obtained in the table on the previous page on a piece of
graph paper and stick it into your workbook. Make sure you label all relevant details.

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 TOTAL REVENUE
So, lets leave costs behind for the moment and concentrate not on money leaving the
firm to pay for items, but on money being received by the firm in return for the sale
of goods and services. This is called revenue.

Revenue - The income that a business receives, as a result of selling its

products. It is calculated as price multiplied by the quantity sold.

However, there are other words which mean the same as revenue and which are used
interchangeably in questions. They could be:

£ Sales £ Selling price

£ Turnover £ Takings
£ Income £ Receipts

Now, just like variable costs, sometimes we talk about revenue in terms of selling
price per unit (the price a customer pays to buy one item) and sometimes we talk
about total revenue i.e. the selling price per item multiplied by the quantity sold.
Total Revenue = Price per item x Quantity sold.
This can be abbreviated to:

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TR = P x Q
Obviously, revenue is always measured in monetary terms. Make sure you use the
right unit (e.g. £, $, ¥) and be careful with the amount of zero’s as very often
questions are asked which give answers in millions – one zero too few or too many
makes a BIG difference!

Question 6

Calculate the total revenue for the firm below.

Item sold Price per item Number sold Revenue per

item
Eggs (1 dozen) £1.20 15 dozen
Cheese (per Kilo) £2.99 9 kilos
Milk (per pint) £0.80 60 pints
Bread (per loaf) £0.70 50 loaves
Butter (per block) £1.50 6 blocks

Total

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 CONTRIBUTION
OK, so things are going to start to get a little more complicated now. So far we have
seen costs and revenues separately. NOW we have to start putting them together and
performing some more calculations.

There are two ways of performing break-even calculations. One way involves total
costs being equal to total revenues (TC = TR). We will look at this later. It is more
long winded and involves more calculations but you have to know how to do it.

The other way is the contribution method. This LOOKS more complicated at first but
is much quicker and gives you more information in the long run. So what is
contribution? It is best illustrated with an example.

Imagine a toy that is sold in the shops for £15 each.

£10 out of every £15 received goes to pay off the

VARIABLE COSTS of making the toy such as paying the
wages of production workers, raw materials and packaging.
That leaves £5.

That £5 could have two uses. For the first toys that are
sold, the remaining £5 goes towards paying off the FIXED
COSTS of the business such as rent, rates and salaries for
management.
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When all of the fixed costs are paid then the remaining £5 from each toy sold will be
PROFIT. From this we can conclude that the formula for contribution must be:

CONTRIBUTION = SELLING PRICE – VARIABLE COST

PER UNIT PER UNIT

Which can be abbreviated to:

Cont. = P - VC

Question 7

a) Draw a profit calculating machine on a piece of plain A4 paper to illustrate

this example with an output of 12,000 units and fixed costs of £50,000 (it
doesn’t have to be a masterpiece)! Stick this into your workbook.

b) Draw a profit calculating machine for the following example related to

birthday cakes:

Selling price per unit = £25

Variable costs per unit = £15
Fixed costs = £25,000
Output = 4000 units

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 CALCULATING THE BREAK EVEN POINT
We have seen from Question 7 above that by using a profit calculating
machine we can work out not just the contribution but also the break-even
point, the margin of safety and the profit achieved. Let’s look at break even
in more detail.

Break-even This is the level of sales/output where neither a profit nor a

loss is being made.

The break-even point is measured in units of output not in money terms. This is one
of the most common mistakes made on these types of questions.

We saw from our work on contribution that when we have paid the variable costs of a
product we should have some revenue left over. This has two possible uses: to pay
for fixed costs or to make a profit. As the definition of break even is where no loss or
profit is made, we need to find the number of units we have to sell in order to cover
all of the fixed costs but before we start to make a profit. Therefore, the formula
required is:
Break even point = fixed costs
contribution

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This gives us an EXACT number of units required to break even. Sometimes you
may get a decimal place (such as 10.5 units). In this case your answer is 10.5 units
but then, on the next line of your calculation, round UP to the next unit (even if the
answer was 10.1 units ALWAYS round up as at 10 units you haven’t technically
broken even yet!)

Question 8

Calculate the break-even point for the following firms.

Firm Selling Variable Fixed Contribution Break even

price (£) costs (£) costs (£) point

A 20 10 15,000
B 5 3 788
C 1,500 1,000 30,000
D 20,000 17,500 35,000
E 44 34 1,800
F 60 30 300
G 120 100 4,800

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However, this is not the only way of calculating the break-even point. There is also
the formula

Break even = Total cost = Total revenue

Let us have another look at the table on page 14. On it we calculated the total cost of
manufacturing a product – in order to find the average cost. If we replace the last
column with one entitled TOTAL REVENUE and assume a selling price per unit of
£12.

Units made Total Fixed Total

per week Total costs Total revenue
costs Variable costs

0 1000 0 1000

100 1000 1000 2000

200 1000 2000 3000

300 1000 3000 4000

400
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1000 4000 5000

500 1000 5000 6000

600 1000 6000 7000

700 1000 7000 8000

800 1000 8000 9000

900 1000 9000 10,000

1000 1000 10,000 11,000

Luckily, we can see that TC = TR at 500 units. But what if it had been 505 units?
Would we have been able to tell EXACTLY as we could with the contribution
method? No, we would have to use trial and error. Alternatively, we could draw a
graph!

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 PLOTTING A BREAK-EVEN GRAPH
When you have calculated the break-even point using either the contribution
method or the TC = TR method, very often you are asked to draw a graph to
illustrate the break-even point.

Luckily, break-even graphs all look pretty similar to each other – that is –
there is a classic shape to them and some double checks we can make to
ensure we are doing it right.

Break-even graphs are line graphs. To make it a little more complicated we

have 4 lines on the same graph. This means it is VERY important to label
everything correctly. In fact, you get the majority of your marks for graphs
in business studies for labelling correctly! Here is a guide to correctly
drawing a break-even chart.

STEP 1) First, the axis. What we are actually plotting are costs and
revenues over a certain number of units of output. Therefore you
need the continuous data (output) along the x –axis (horizontal)
and the dependant data (costs and revenues) on the y-axis
(vertical).

Finding the correct scale for your graph is probably the hardest
part and MANY students have problems with this. However,

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there is a good rule of thumb. Before you draw a graph you
should have worked out the break-even point (using the
contribution method). You will therefore know how many units
you need to produce for TC to equal TR. However, we want to
show MORE units than we actually need to break even (as you
will see later) so, label the x axis output and then either:

a) Add 50% on to the break even point and make that your
maximum number on the x-axis
or
b) Use information from the question to find the MAXIMUM
output of the firm in question (their capacity). For example, in
the data we have on page 20, we can assume the maximum
output is 1000 units.

STEP 2) That is the x-axis taken care of, but what about the y-axis. This
is easier once you know your maximum output (or the biggest
number on the x-axis). We know that revenue is equal to price x
quantity (TR = P x Q) and, as you will see in a minute, the
highest point on a break-even graph is the last point on the
revenue line. This means that if we find the revenue gained from
selling the maximum output on our x-axis, this is the biggest
number we need to go up to on our y-axis!. Don’t forget to label
the axis costs and revenues and put the appropriate currency
symbol too (£,$, ¥ etc).

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STEP 3) Now our axis are in place and labelled we can plot our first line –
fixed costs.

This is the easiest line to plot as it is a horizontal line straight

across the graph! Remember, it doesn’t matter how many units
of output we make, fixed costs remain the same. Label the line
FC.

STEP 4) Next comes variable costs. This is trickier as we may or may

not have worked out the data for this already.

If you have a table of figures which includes a column for VC

(see page 20) then plotting the figures is straightforward.

If, however, you have used the contribution method what should
you do? Well, to plot a straight line you really only need 2
points on that line (the first and last). We know that if we make
zero units of output that our variable costs are zero. We should
also know the variable cost per unit. Knowing these two facts
we can find what the total variable costs would be at our
maximum output (the last number on the x-axis). This is the last
point on our line. Simply join this up to zero. You can plot a
point in the middle as well, if you want to be certain your line is
correct. It should be a straight, diagonal line. Label this VC.

STEP 5) www.igcsebusiness.co.uk
We can now plot our final cost line which is total costs. This
has a couple of special characteristics, which makes it easier to
plot accurately.
First, the TC line does not start at zero. It starts from the same
place the fixed cost line does.
Secondly, the VC and TC lines are parallel. That is, they are the
same distance apart all the way along.
Finally, the distance they are apart is the same distance as the FC
line is from the x-axis. If you think about it this makes sense as
what does TC equal? FC + VC! Therefore, when you have
plotted your TC line, you should be able to count the same
number of squares on your graph paper between the two sets of
lines. This is a great way to check and make sure you are
plotting accurately.
So we know the characteristics of the line and, if we have a table
of figures, we can plot it easily. But, what if we are using the
contribution method? Again you would have to work out the
first and last points of the line. We know the line STARTS at
the junction of the FC line and the y-axis but where does it
finish? You would need to use the formula TC = FC + VC to
work out the TC for the maximum output (or the biggest number
on the x-axis of your graph). Obviously label the line you have
just plotted TC.

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STEP 6) We are now ready to plot our final line – the revenue line.
Luckily, this should be straightforward whatever method you
have chosen.

If you have a table of figures then, as with the previous lines, it is

simply a case of plotting the figures you have.

If you are using the contribution method then you will already
have the two points needed to plot your line. If we sell no units
then we get zero revenue – so the line starts at zero.

You have already worked out the maximum revenue obtained

and used this as the top figure on your y-axis (see step 1 earlier).
It is simply a matter of joining these two points up. Label the
line TR.

STEP 7) If you have completed step 5 correctly, the TR line should have
crossed the TC line at some point – HOPEFULLY at the same
number of units that you calculated the break-even point to be.
(What a coincidence!) This is obviously because the break-even
point is where TC = TR.

To show the break-even point on your graph, draw a dotted line

(with a ruler please!) DOWN to indicate the number of UNITS

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required to break-even on the x-axis and label this BEP (Break-
Even Point). Remember, we don’t think of the break-even point
in terms of money so DO NOT draw a dotted line ACROSS to
the y-axis.

STEP 8) We have a couple more labels to add. These are the areas of
profit and loss. We know that – until we reach the BEP – we are
making a loss. Therefore, from the y-axis moving right across
the graph the TC line is higher than the TR line UNTIL THE
BEP IS REACHED. The area of the graph between these two
lines is the area of loss. Shade it in and write LOSS in the area.

STEP 9) Immediately after the BEP the TR line will become higher than
the TC line. The area between these lines moving right towards
the edge of your graph is the area of profit. Shade in the area
between the lines and label it profit.

STEP 10) Give your graph a title – something like “Graph to show the
break-even point of …………” (add whatever product the firm in
question makes or, if you don’t know the product, the name of
the firm).

Phew! You have now completed a break-even chart. Congratulations.

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Question 9

Complete a summary below, in the form of a flow chart, of the ten-step process of
producing a break-even chart. Illustrate it with examples of the graph at each stage.
This will be a handy revision tool later on in the course.

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Question 10

Using the following data, construct a break-even chart using the contribution
method and stick it in your workbook.

Selling Variable Fixed Capacity

Firm
price (£) costs (£) costs (£) (units)
A 20 10 15,000 2,300

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 THE MARGIN OF SAFETY
Wow, we have come a long way since we started to look at the very basics of fixed
and variable costs! But, our journey is only half way complete. After having
calculated the contribution and the break-even point, we can now move on to the
nitty-gritty of most businesses – profit!

When we drew our profit calculating machines on page 18 we came across a term
MARGIN OF SAFETY. Write a definition of this term below.

Margin of safety

Therefore the formula for calculating margin of safety is:

Margin of safety = Output – Break-Even Point

If using the contribution method to calculate profit then you need to know the margin
of safety. If we know how many units above the break-even point a business is
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producing, and we know the contribution each unit makes to the profit, then it is
simple to calculate what that level of profit should be.

You may be asked to mark a margin of safety on a break-even graph. This can be
achieved by drawing a line or an arrow below the x-axis from the break-even point to
the level of output mentioned in the question, and writing below the line or arrow
what the margin is (the answer is in units of output remember).

Question 11

Calculate the break-even point and the margin of safety for the following
companies.

Break-
Selling Variable Fixed Capacity Margin
Firm even
price (£) costs (£) costs (£) (units) of safety
point
A 5 1 4,000 17,000
B 25 3 66,000 7,500
C 33 3 9,000 1,050
D 67 17 94,000 6,400
E 98 48 5,550 150

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 CALCULATING PROFIT
Using the costs and revenues

If you have so far used calculations to find fixed costs, variable costs, total costs and
total revenue then you need to continue using these figures to calculate profit.

The formula to calculate profit is:

PROFIT = TOTAL REVENUE – TOTAL COSTS

Profit is the difference between the money coming into a firm, and the money leaving
the firm in the same period of time.

Using contribution

If, however, you have so far used the contribution method to calculate break even,
then you must continue and use the information gathered so far to calculate profit.

The formula to use in this case is:

PROFIT = MARGIN OF SAFETY x CONTRIBUTION

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You have already calculated both of these figures previously, it is simply a case of
multiplying them together.

Question 12

Calculate the profit earned in the following businesses. Use the given method of
calculation in each case and show all your workings on the back of the page.

Selling Variable Fixed Capacity Profit Method to

Firm price (£) use
costs (£) costs (£) (units)
A 20 7 13,000 1,500 Contribution
B 60 22 114,000 6,500 Costs
C 110 75 17,500 1,050 Contribution
D 55 25 210,000 9,450 Costs
E 102 39 37,800 1,200 Contribution

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 FORMULA SHEET

Average variable costs = Total Variable Costs

Output

Total variable costs = variable costs per unit x output

TC = FC + TVC

Or

TC = FC + (VC per unit x OUTPUT)

Average (or unit) cost = Total Costs

Output

Total Revenue = Price per item x Quantity sold.

Or

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TR = P x Q

CONTRIBUTION = SELLING PRICE – VARIABLE COST

PER UNIT PER UNIT

Or

Cont. = P – VC

Break even point = fixed costs

contribution
Or

Break even = Total cost = Total revenue

Margin of safety = Output – Break-Even Point

PROFIT = MARGIN OF SAFETY x CONTRIBUTION

Or

PROFIT = TOTAL REVENUE – TOTAL COSTS

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 GLOSSARY TERMS

Average cost Also called unit cost. The total costs of producing a product divided by the number of units
produced. Over a short period of time it is expected that as output increases, average
costs will fall to start with and then rise again as the factory moves towards full capacity.
See economies/diseconomies of scale

Break-even This is the level of sales/output where neither a profit nor a loss is being made. It is a
simple model, often represented in the form of a graph, which can show a business the
level of sales/output required if its total revenue is going to cover its total costs. Can be
calculated using the formula
Break even point = fixed costs ÷ contribution

Capacity A general term given for the resources that are available in a business for production
including machinery, plant and labour.
Or, the maximum amount of output that can be achieved with a specified level of the
factors of production.

Contribution Calculated using the following formula:

Selling price per unit – variable costs per unit
The contribution is used to pay for fixed costs. Once these are paid, any remaining
contribution is profit.

Costs The money a business spends in order to produce goods and services for its consumers.
They can be classified as variable, fixed, direct, indirect, total, average (or unit) and

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marginal.

Cost plus The basis of a pricing decision. The costs of production are calculated and then a
pricing percentage mark-up is added to make sure a profit is made.

Direct costs The costs which are allocated specifically to a product, machine or department in a
business, and which will increase or decrease in relation to the output of that section.
These include raw materials and labour costs.

Fixed costs Those costs of a business, which remain unchanged at whatever level of output the
business is producing at over a period of time. These include rent, depreciation and
salaries.

Indirect costs Those costs that cannot be directly identified with a particular cost centre in a business.
The costs of energy, administration and security are examples.

Margin of The number of units of production above the break-even point produced by a firm.
safety Calculated by: Output – break-even point

Price The element of the marketing mix that refers to pricing policies. Price is the market value
of goods and services that are bought by consumers and firms.

Sales revenue The income that a business receives as a result of selling its products. It is calculated as
price multiplied by the quantity sold.

Variable costs The costs that change directly with the output of a business. They are likely to include
wages and raw materials.

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