Costs, Profits and Break-even Analysis

Costs, Profits and Break-even Analysis

Alas, this means coming to terms with numbers, something that seems to

frighten a large proportion of Business Studies students. Before

reaching the stage of actually drawing a break-even diagram we need to

think what actually goes into one. First, we need to look at costs.

They can be referred to in terms of output, time or product. When we

speak of costs in terms of output and time we mean FIXED and VARIABLE

costs. Remember fixed costs do not vary with output, whilst variable

do. The TOTAL costs of a firm are its fixed and variable costs added

together. We also need to remember that we borrow something from

economists when we introduce time to the calculation. By this I mean

the dreaded long and short run. Remember that in the short run the

scale of the operation cannot be changed and any expansion in output

has to come from what spare capacity may be available. In the long run

the entire scale of the operation can be altered. Quite literally the

company can open a new factory to meet the increase in demand for its

products.

When looking at the actual product we need to remember that the costs

we must now calculate are the DIRECT and INDIRECT costs. Some people

prefer to call indirect costs overheads. Direct costs involve all the

costs that can be directly related to the product or service. An

example of this would be the materials needed to make a specific

product. Indirect costs are those which cannot be directly allocated

to a specific product or service. This might be the postage or

telephone costs, which cannot normally be allocated to just one

product or service. When we add the direct and indirect costs together

we get what are known as the Total costs for the product or service.

We also need to make certain that we understand what is meant by the

term profit. What comes into the business via sales is the revenue and

what goes out are the costs.