3.2+(FLIP)+Costs+&+Revenue

=** COSTS & REVENUE **=

The rules of FLIP.
 * You (the student) access the information for the first time, at home - outside the classroom, away from the teacher.
 * You attempt to understand it by yourself.
 * You bring any doubts, questions, concerns you have to the classroom, and the lesson is spent clarifying doubts & extending knowledge.

(this Unit is really about getting the building blocks ready for the next units - understand exactly whats costs & revenue are and the units that follow are easier)



__**NOTE :**__ 'PROFITABILITY'= (TOTAL PROFIT / TOTAL REVENUE) * 100 REVENUE is good news, so lets start with that first.

SALES REVENUE
(think of 'Sales Revenue' as being her full name, while some friends call her 'Sales' and others call her 'Revenue') //confusingly it is also sometimes called SALES TURNOVER. Maybe think of Turnover as her maiden name?//

Sales Revenue is the "total amount of sales made" (measured in $) In real life you may hear a Seller say things like "I sold 10 products" - that is fine they can say what they like, we are not Language Police, but for IB exams we look at Sales Revenue as being measured in currency. We would say "I made $500 in Sales"

Sales Revenue is calculated via the formula =SALES REVENUE == PRICE PER PRODUCT * NUMBER OF UNITS SOLD

__//An issue that can confuse//__ : "Sales Revenue" is a term most associated with the 'Profit & Loss Account' (to be examined later, and also sometime referred to as an 'Income Statement'), though it can come up anywhere, most noticeably in the 'Cashflow Account' (also to be studied later). The Cashflow Account itself has a term in it called 'Inflows'. **Inflows** and **Sales Revenue** are **similar** in that they both represent money coming into the business, **but** they are **not the same**. Hopefully the difference will become clear later on.

While Sales Revenue is by far the most famous Revenue there are other members of __//** the Revenue family **//__! " ** Revenue ** " : // anything that causes money to enter the business - that does __not__ have to be paid back. //

Examples of other Revenue Streams
 * sales of fixed assets
 * interest earned from balance in the bank
 * government grants
 * etc etc

__**finally :**__ not to be confused with Profit A firm can make Sales, sometimes very good Sales, but NOT be profitable, Here is the relationship between the two : **PROFIT = REVENUE - COSTS** //* bearing in mind we have already said both 'Profit' and 'Costs' are vague terms//



//That's it : i hope we know what Sales revenue is - and how it relates to connecting issues.// COSTS is the bad news, but you cant ignore it.

Here is a rough but workable __definition__ of what a COST is :

"any activity that causes money to leave the business"
eg Paying for supplies is a COST Paying for advertising is a COST Paying for rent is a COST etc

The only exceptions to this arise when we look at the Profit & Loss Account - they don't really treat Paying interest on loans, and Paying taxes to the government as normal costs. It is not an important point for now though.

The __ //**KEY IDEA**// __ here is to know that there are costs that are directly linked to production of a unit, and costs that are not.

These two costs are two different beasts

The importance of this difference lies in the question "**should we make more units or not?**" If we make more, our Variable Costs go up, if we make less our Variable costs go down. Fixed Costs remain the same either way. As we can control how many units we produce //we can also therefore control Variable costs more easily than Fixed.//

SALES REVENUE - VARIABLE COSTS - FIXED COSTS = PROFIT This formula is the heart of the Profit & Loss Account. It is NOT a formula you need to learn but just so you know the link when we study that topic.

(it is not an exhaustive example - but good enough to make the point)
 * Here is an example of the difference - connected to McDonalds : Variable Costs on your left & Fixed on the right.**



Variable Costs are always nice and easy to identify, because they are directly associated with that particular unit. Fixed costs are a different beast - we know we have to pay $1000 rent, and we know we gain revenue by selling burgers but how much of that rent is associated with each individual burger. The answer could be straight forward : we sell 1000 burgers, so each burger must cover $1 worth of rent. Real life is often way more complicated though, because most firms sell more than one product. Say those 1000 burgers come from 500 sales of HUGE burgers, 300 medium sized burgers and 200 tiny burgers - how much of the rent should each burger cover ( to ignore desserts, drinks etc)? Not impossible to calculate but certainly more complex than Variable costs !!

__//** "WILL PRODUCING ONE MORE UNIT LEAD TO AN INCREASE IN THIS COST?" **//__ Sometimes its not easy to classify a cost so here is the golden rule : If the answer to the question above is....
 * YES then its a VARIABLE COST.
 * NO then its FIXED...
 * SOMETIMES then its ** SEMI-VARIABLE **

// * you don't change the oil every time you fry a new batch of chips, but at some point you will need to, and the cause of purchasing new oil will be because you made one more unit : therefore it is 'sometimes'. //
 * Every time i produce a new burger I incur the extra $0.30 of a new __ bun __ . Every time. Therefore Yes, 'buns' are a Variable Cost
 * I can produce an extra burger and have no new __ rent __ cost, therefore the answer to the question is No, so 'rent' is a Fixed Cost.
 * __ Oil __ for the fryer [in the case of French Fries) is tricky, but just apply the question. Your answer is 'sometimes'* - therefore 'oil' is a Semi-Variable Cost

See this table below for the connection between Variable Cost, Price & whether to produce more or less. I have connected it to the McD information above.



Do you get the point? Price must be higher than Variable Cost or the more you produce the more you hurt yourself!

Here's a small image to re-enforce that point

So we know ALL costs are divided into Fixed Costs & Variable Costs. This takes us to the question..

The answer is on the powerpoint document below

A **common mistake** in these cases is to forget the difference between TOTAL VARIABLE COST & VARIABLE COST PER UNIT. //I have regularly seen people quote the answer for Total Costs as $501.05. This is WRONG!// //Each new unit produced and the TOTAL Variable Costs go up!//

Speaking of common mistakes. : a common error when defining Fixed Costs

=** Two other costs ** : you will hear of the terms Direct Costs & Indirect Costs.= I will not really develop the explanations of these because in most contexts they are so similar to the two we already know.

Direct costs are those associated directly with the producing of the product - pretty much the same as Variable Costs. Indirect costs are the opposite. You have to pay them, but its difficult to say the production of which product caused the cost. They are only indirectly associated with a product being produced - pretty much like Fixed Costs.

- and that's your lot: the Good news (Revenue) and the bad news (Costs)!



Here's what the IB syllabus says you need to know

IB Students should be able to understand and apply the following
 * types of costs, using examples (i) Fixed (ii) Variable (iii) Semi-variable (iv) Direct (v) Indirect
 * Total Revenue, Revenue Streams - using examples

if you can do that then you're covered for this part of the syllabus.



Here is a checklist of questions to test your understanding