Financial Knowledge and Skills for Business: Week 8

  • Created by: EvemChas
  • Created on: 26-01-23 17:19

Cost: Part 1

Definition of Cost

'The amount of resources, usually measured in monetary terms, sacrificed to achieve a particular objective.'

2 Types of Cost

  • Historic Cost: Cost already incurred
  • Opportunity Cost: Value of opportunity forgone

Relevant and Irrelevant Costs

  • Relevant Cost: Type cost related objectives of business, related future + can vary with decision.
  • Irrelevant Cost: Type cost isn't related objectives of business, not related future + doesn't vary with decision.
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Cost: Part 2

The Behaviour of Costs

Costs may be broadly classified as:

  • Fixed Cost: Those stay fixed/same, changes occur volume activity.
  • Variable Cost: Those vary according volume activity.

Cost Categories

  • Cost sale, Operating expense + Interest
  • Fixed , Variable + Mixed costs
  • Expense, Material + Labour costs
  • Direct + Indirect costs
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Break-Even and Contribution: Part 1

Contribution Format Income Statement

  • Contribution Margin = Sales - Variable Expenses
  • Contribution margin must first cover fixed expenses
  • If doesn't = loss
  • As additional units sold, total contribution margin + until fixed expenses been covered.

Break-Even Chart

  • Anything above break-even point counts as profit.
  • Anything below break-even point counts as loss.

Calculating Break-Even Units

  • Break-even point, total contribution margin = total fixed costs.
  • Use this knowledge calculate number units must sell break even.
  • Formula: Break-Even Units = Total fixed expenses/Contribution margin per unit.
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Break-Even and Contribution: Part 2

Contribution Margin

Ratio: Contribution Margin = Contribution margin/Sales x100

Break-Even Sales Value

  • Formula 1: Break even sales value = Break even sales units x Selling price per unit
  • Formula 2: Break even sales value = Fixed expenses/Contribution margin ratio

Margin of Safety

  • Amount by which current sales exceed break-even sales.
  • Terms sales revenue, margin safety: Total sales revenue - Break even sales revenue
  • Terms units, margin safety: Total sales units - break even sales units

Target Profit Analysis

Unit Sales Required = Fixed expenses + Target profit/Contribution margin per unit

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