Costs and Revenues - Quick Notes

Costs and revenues

• Costs: total expenditure a business incurs to run its operations.
• Revenue: money generated from selling goods/services; also known as turnover.
• Profit: difference between revenues and costs; $Profit = TR - TC$.
• High positive difference indicates business success.
• Revenue is not the same as profit.
• Total revenue (TR) basics: $TR = P \times Q$; AR (Average Revenue) is the same as price: $AR = P$.
• Note: TR includes all income whether sales are on cash or credit.

Costs

• Costs refer to the amount spent to purchase resources needed to produce or sell a product.
• Two broad categories: 1) Fixed costs 2) Variable costs; and 2) Direct costs 3) Indirect costs (overheads).

Fixed costs

• Definition: costs paid regardless of output level (e.g., rent, salaries, insurance).
• Change not caused by production volume; can change due to external factors (e.g., a raise in internet fees).

Variable costs

• Definition: costs that change with output level (e.g., raw materials, piece-rate wages).
• More output increases variable costs (e.g., more shampoo used as more haircuts are performed).
• Key distinction: fixed costs do not relate to output; variable costs do.

Total costs

• Formula: $TC = TFC + TVC$
• Total costs are the sum of total fixed costs and total variable costs.

Direct costs

• Costs that can be clearly attributed to the production of specific goods/services (costs centers).
• Examples: cost of flour in bread, labor in car production, chicken in a fast-food restaurant.
• Typically include raw materials, direct labor, and packaging costs.

Indirect costs (Overheads)

• Costs that cannot be traced to a particular product.
• Examples: rent, office salaries, audit fees, insurance, advertising, security, interest on loans, warehouse costs.
• Also known as overheads.

Overheads categories

• Production overheads: factory rent, depreciation, power.
• Selling and distribution overheads: warehouse, packaging, distribution, sales salaries.
• Administration overheads: office rent, clerical/executive salaries.
• Finance overheads: interest on loans.

Indirect vs direct costs relationship

• In most cases indirect costs are fixed while direct costs are variable.
• However, both can be fixed or variable depending on the business activity.

Revenue streams

• Revenue can come from multiple sources beyond core trading activities.
• Examples: rental income, sale of fixed assets, dividends, interest on deposits, donations, grants and subsidies.

Benefits and drawbacks of multiple revenue streams

• Benefits:
  • Higher total revenue; diversification reduces risk when one stream weakens.
• Drawbacks:
  • More management and control required; potential loss of focus on central business activity.

Revenue streams (illustrative example)

• Firms may have multiple revenue streams across products and services (e.g., devices, services, digital content).