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BUSINESS COSTS, REVENUE AND BREAK EVEN

Introduction

All businesses need to keep records of how much money they are spending and how much money they are receiving in. If they do not do this they could end up losing a lot of money and even getting into trouble with the tax authorities. This article is about three important money terms revenue, costs and break even.

1. Revenue

Revenue is the money that comes into the business e.g. from sales, interest on savings, product licensing and rent agreements. Sales revenue is calculated by multiplying the number of sales, with the price charged for the items sold. For example if I sell ten sweets for £1.20 my revenue is £12.00. Do not confuse sales revenue with profit as revenue looks at how much money has come into the business, without taking costs into account. Whereas profit looks at how much money has come into the business and the costs involved in generating that money.

2. Costs

Costs are categorised in two ways; fixed costs and variable costs or start up and running costs. The items that make up costs depend on the type of business and its setup.

Fixed costs or Overheads

These are costs that will not change if the business increases or decreases business activity. This means fixed costs have to be paid even when the business is not carrying out any business activity. Examples of fixed costs or overheads are rent for the business premises, interest on loans or business rates charged by local government/councils and salaries. It is worth remembering fixed costs may not be fixed for ever for example landlords may change the amount of rent or loans may be paid or increased. Fixed costs are said to be connected with time (time related) as they have to be paid regularly i.e. weekly monthly quarterly annually.

Variable Costs

These are costs that will change if business activity changes. This is because when business activity increases more resources such as materials and utilities (gas, electricity, fuel etc) are used. Conversely when business activity decreases the business needs less resources.

 

Start-Up Costs (Sunk Or Set-Up Costs)

As the name suggests start-up costs are costs that the business needs to pay before it can start business activity. Start up costs include purchase of machinery, premises, office equipment and furniture. Start up costs are only paid once i.e. at the beginning.

Running Costs (Operating Costs)

Running costs are costs that the business has to pay throughout its life. Running costs can be fixed costs such as rent or variable costs such as gas bills.

3. Break-even Point

This is the point at which the total amount of money received from the sale of goods (sales revenue) is exactly the same as the amount of money it cost to produce or buy the goods. This means that at break-even point the business has not lost any money and it has not made a profit. If the cost of sales increases e.g. because material prices have increased then the break-even point will move, as the business will need to generate more sales revenue to match the increase.

 

Break Even Point Diagram

Conclusion

It's important to understand business costs at every step of the business process. At business start up stage you need to predict the number of sales and compare this against how much it will cost to sell products. This will help you decide whether you are likely to make a profit and minimise losses.

Once the business is up and running, a regular break even point analysis is important to discover whether you are still making enough profit. If the break even point analysis reveals a low profit, you will need a plan to increase sales or reduce costs.


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