Financial Formulas Explained

Formula's used in business finance for the AQA new specification (AS) and recap of why they work.

Covers:

  • Total Revenue
  • Total Costs
  • Contribution
  • Break Even
  • Gross & Net Profit
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  • Created by: Sheldon
  • Created on: 09-01-09 16:50

Total Revenue

IF Total Revenueismore thanTotal Coststhe firm makes aPROFIT

Total Revenue > Total costs = PROFIT

IF Total Revenueis less thanTotal Coststhe firms makesaLOSS

Total Revenue < Total Costs = LOSS

IF Total Revenueis the same asTotal Coststhe firmBREAK EVEN

TOTAL REVENUE = PRICE PER UNIT (Product) X QUANTITY SOLD (Also know as TR=P X Q)

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Costs

Total Costs = Fixed costs + Variable Costs

Fixed Costs are costs which don't change with output. For example, whether the firm makes any products or not they will still have to pay rent

Variable Costs therefore are costs which are directly affected by the production line e.g. raw materials are varible costs because how muchthe firmspends on them depends on how much output the firm produces

Total Costs therefore are both fixed and variables added together

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Contribution

Contribution = Selling Price per unit/product- Variable Cost per unit/product (C=P X VC)

Contribution is the amount made per unit produced which, when sold, the money made goes towards paying off fixed costs. IT IS NOT YET PROFIT.

Another way to explain is that contribution is the difference between the variable cost of producing the unit and its selling price.

Total Contribution =Contribution per unitXQuantity of units sold(TC=CPU X Q)

Total contribution therefore is the amount made from multiple sales which contribute towareds fixed costs or overheads.

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Break Even Analysis

This can be done using the following formula:

BREAK EVEN = FIXED COSTS / CONTRIBUTION PER UNIT

This formula gives you the amount of units which need to be sold in order for the firm to break even.

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Gross & Net Profit

Gross Profit = Direct Costs - Revenue

Gross profit is a larger amount that Net Profit. It becomes Net Profit when fixed costs are taken away from the amount

Direct costs are those directly associated with the production fo a product e.g. raw materials and hourly wages of the staff who produce the product are direct costs.

Indirect costs therefore are costs inccured which don't directly have anythign to do with producing a product such as the hourly wages of the canteen staff who provide a service within the firm to the workers. They aren't directly involved with producing the product which the firm then sells to consumers.

Net Profit = Total Costs - Revenue

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