Financial Knowledge and Skills for Business: Week 8

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.

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

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.

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