Costs, Revenues and Profit

Costs, Revenues and Profit

View a mind map for this resource.

Introduction:

These are three very important concepts in business that you must have some understanding about. The following outlines some of the main things to learn.

1. Total revenue

Total revenue (TR) is the amount earned by a firm from the sale of its products. It is also called ‘turnover’ or ‘sales revenue’ or simply ‘sales’.

Total Revenue is found by multiplying the price of the product by the quantity sold – the formula for this is:

TR = P x Q

Tasks:

Jason runs a hairdressing salon. He has the following sales information for one week:

  • 18 cut and finish (6 of which included straightening)
  • 14 children’s’ cuts
  • 8 Gent’s wet cuts
  • 5 foil highlights
  • 8 colour two tones

The salon's price list is as follows:

  • Foil highlights: £70
  • Colour two-tones: £70
  • Gent’s wet cut: £12.50
  • Cut and finish: £24.50
  • Straightening: £3
  • Child’s cut: £7

1. Calculate the total revenue for the week.

2. Did Jason make a profit this week? Explain your answer. (Hint - this question is designed to make you think a little!)

Zoltan and Maria run a hand car wash business. They charge £10 for a basic wash and dry, £15 for a wash and wax and £20 for a full wash and valet service.

In the month of October they did 50 basic washes, 12 full wash and valet services and 28 wash and wax services.

3. Calculate the total revenue for the month.

If a firm wants to increase its total revenue it can really only do one of two things:

  • Increase or decrease its prices
  • Do something to encourage more sales, using other aspects of the marketing mix – product, place, promotion, etc.

Tasks:

4. Jason wants to find a way of increasing revenue at the salon. Apart from changing his prices, discuss two possible ways he might do this.

5. Zoltan and Maria have competition from a nearby supermarket car wash. They currently charge 25% less than the supermarket does. They are considering increasing their prices to try to increase revenue.

Advise them of one advantage and one disadvantage of doing this, and what the implications might be in each case.

2. Total Cost:

Total cost (TC) is the total amount spent by a business in producing the good or service and ensuring it gets to its customers. You may sometimes see reference to ‘ cost of sales’. It must be remembered that this means how much it costs to produce the goods it has sold, NOT how much it earned from selling them. This is invariably where students go wrong when calculating profit margins! Cost of sales is just one element of total costs – there are other costs that are not directly related to what the business produces, and these must also be taken into account when calculating total costs.

The formula for total costs is:

TC = FC + VC

Fixed costs (FC) are the costs that do not DEPEND on the amount produced – rent, insurance, advertising, administration costs, etc. They have to be paid whether the business produces and sells anything or not.

Variable costs (VC) vary directly with the amount produced – they will rise if more is produced and fall if less is produced. Variable costs are things like raw materials, some types of energy and some types of labour cost.

Task:

Look at the following cost items in Jason’s salon.

6. Identify which are fixed costs and which are variable costs. Explain your answer

  • Shampoo used to wash clients’ hair
  • Electricity costs for powering hairdryers and straighteners
  • Insurance costs for the building
  • Colours used for hair styling
  • Rent on the premises he uses
  • Scissors for cutting each client’s hair
  • Water charges (Jason has a water meter)
  • Advertising costs (usually averaging out at £200 per month)
  • Appointment cards
  • Heating and lighting costs

7. Identify three possible fixed and three possible variable costs for Zoltan and Maria’s car wash business.

3. Profit

Profit is the difference between what a firm receives from selling its products (TR) and how much it has spent in producing them (TC) over a period of time.

The formula is:

Profit = TR – TC

If the TC is greater than the TR then the firm has made a loss. This can be shown as a bracketed figure, for example if TR in one week is £3 000 and TC for that week is £3 500 then the profit is (£500) – in other words a loss of £500. This can also been expressed as a negative figure, for example, profit for the week is −£500.

A common mistake is to confuse profit and revenue and profit and cash flow – they are not the same thing.

Tasks:

Jason is completing a spreadsheet for his accounts to check on his financial performance for the month. He has calculated that each client, on average, generates £30 in revenue. He has compiled the following information so far.

Number of clients per week:

  • Week 1 = 35
  • Week 2 = 42
  • Week 3 = 38
  • Week 4 = 45

Fixed Costs (£) per month = £1 800

Variable Costs (£) per week per customer = £18

8. Use the information to construct a suitable table to show the total cost, the total revenue and the profit/loss for the month.

Zoltan and Maria have been told by their accountant that they made a profit of £8 000 last year. Included in their costs were wages that they paid each other, so they were quite pleased with this profit. They are now trying to forecast their sales for next year to have some idea what might happen to their profit.

9. Explain how Zoltan and Maria could estimate the sales they might make next year.

10. Outline four other factors that they might have to consider in forecasting their profit for next year.