Calcuating Cost, Revenue and Profit

Setting up or running a business incurs costs. It is important for a business to analyse and forecast these costs, and plan how they can be covered. Start-up costs can be high for new businesses, and so entrepreneurs may need to secure external finance (usually in the form of a bank loan or private investor) to cover these costs.

Fixed costs are expenses that do not vary in line with changes in demand or output - i.e. they remain constant. They have to be paid whether any products are made and sold or not. e.g. rent, depreciation, salaries, interest charges Variable costs are those incurred by a business that vary in direct relation to the level of ouput and demand - i.e. as output rises or falls, so do variable costs. e.g. materials, power, labour costs Total costs = fixed costs + variable costs If a business person can set his or her prices at a level that covers the business's total costs, then it will make a profit (although this assumes that the products will sell at the chosen price and that sufficient numbers are sold).

Revenue is the total value of sales made by a business over a specified period of time. This is also called sales revenue or total revenue.

Revenue is calculated by: revenue = quantity sold x (average) selling price per unit

However, an increase in price does not automatically increase a business's revenue! Whether or not revenue will increase following a price rise will depend on how many customers stop buying the product. If a price rise is not accepted well by customers (i.e. they stop buying the product because it is too expensive) then revenue may fall. A new business should undertake market research into how sensitive the demand of potential customers is to changes in the price of the product.


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