Introduction to Business Costs

• Definition: Business costs are the amounts a business incurs to operate, make goods, or provide services.
• Importance:
  • Costs influence a business's profit performance.
  • Poor cost management can lead to cash flow problems.

Types of Costs

1. Variable Costs

• Definition: Costs that change as output changes.
• Characteristics:
  • Increase with higher output.
• Examples:
  • Raw materials, consumables, and components for manufacturers.
  • Retailers and wholesalers' inventory costs.
  • Labor costs that vary with production (e.g., pay per unit produced).
  • Marketing costs, such as commission based on sales revenue.

2. Fixed Costs

• Definition: Costs that do not change with output levels.
• Characteristics:
  • Remain the same regardless of the output change, though they can vary from one period to another (e.g., rent, salaries).
• Examples:
  • Salaries, advertising costs, rent, IT systems, insurance, and fees.

Calculating Total Costs

• Formula: Total Costs = Fixed Costs + Variable Costs
• Example Calculation:
  • Forecast total costs for March:
    • Variable Costs per Job = £75
    • Expected Jobs = 100
    • Total Variable Costs = 75 * 100 = £7,500
    • Fixed Costs (e.g., rent, wages, advertising) = £25,000
    • Total Costs = Variable Costs + Fixed Costs = £7,500 + £25,000 = £32,500*

Impact of Output on Costs

• As output increases, fixed costs are spread over more units, leading to a decrease in the cost per unit.
• Example Table:
  • Fixed Costs remain constant at £10,000.
  • Variable costs vary with output (e.g., £100 per unit).
  • Cost per unit decreases as output increases due to fixed costs being shared among more units.

Summary

• Understanding the distinction between variable and fixed costs is crucial for managing business expenses effectively.