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Costs and BudgetingCosts and Budgeting
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ABDULLAH
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Costs and BudgetingCosts and Budgeting
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CostsCosts
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CostsCosts
Anything incurred during the productionof the good or service to get the outputinto the hands of the customer
The customer could be the public (thefinal consumer) or another business
Controlling costs is essential tobusiness success
Not always easy to pin downwhere costs are arising!
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Cost CentresCost Centres
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Cost CentresCost Centres
Parts of the business to which particularcosts can be attributed
In large businesses this can bea particular location, sectionof the business, capital assetor human resource/s
Enable a business to identify wherecosts are arising and to manage thosecosts more effectively
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Full CostingFull Costing
A method of allocating indirect costs to arange of products produced by the firm. e.g. if a firm produces three products - a, b, and c
- and has indirect costs of 1 million, assumeproportion of direct costs of 20% for a, 55% for band 25% for c
Indirect costs allocated as 20% of 1 million to a,55% of 1 million to b and 25% of 1 million to c
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Absorption CostingAbsorption Costing
All costs incurred are allocatedto particular cost centres directcosts, indirect costs, semi variablecosts and selling costs
Allocates indirect costs moreaccurately to the point where
the cost occurred
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Marginal CostingMarginal Costing
The cost of producing one extra unit
of output (the variable costs) Selling price MC = Contribution
Contribution is the amount which cancontribute to the overheads (fixedcosts)
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Standard CostingStandard Costing
The expected level of costsassociated with the productionof a good/service
Actual costs Standard costs =Variance
Monitoring variances can helpthe business to identifywhere inefficiencies or efficienciesmight lie
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Total RevenueTotal Revenue
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Total RevenueTotal Revenue
Total Revenue = Price x Quantity Sold
Price can be raised or loweredto change revenue price elasticity
of demand important here Different pricing strategies can be used
penetration, psychological, etc.
Quantity Sold can be influencedby amending the elementsof the marketing mix 7 Ps
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Break EvenBreak Even
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Break Even AnalysisBreak Even Analysis
Costs/Revenue
Output/Sales
Initially a firmwill incur fixedcosts, thesedo not dependon output orsales.
FC
As output isgenerated, thefirm will incurvariable costs these varydirectly with the
amountproduced.
VC The total coststherefore(assumingaccurateforecasts!) is thesum of FC+VC
TC Total revenue isdetermined bythe price chargedand the quantitysold again thiswill bedetermined by
expectedforecast salesinitially.
TR The lower theprice, the lesssteep the totalrevenue curve.
TR
Q1
The break evenpoint occurs wheretotal revenueequals total costs the firm, in thisexample, wouldhave to sell Q1 to
generate sufficientrevenue to cover itscosts.
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Break Even AnalysisCosts/Revenue
Output/Sales
FC
VCTCTR (p = 2)
Q1
If the firmchose to setprice higherthan 2 (say3) the TRcurve wouldbe steeper they would nothave to sell asmany units tobreak even
TR (p = 3)
Q2
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Break Even Analysis
Costs/Revenue
Output/Sales
FC
VCTC
TR (p = 2)
Q1
If the firmchose to setprices lower(say 1) itwould need tosell more unitsbeforecovering itscosts.
TR (p = 1)
Q3
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Break Even Analysis
Costs/Revenue
Output/Sales
FC
VC
TC
TR (p = 2)
Q1
Loss
Profit
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Break Even Analysis
Costs/Revenue
Output/Sales
FC
VC
TC
TR (p = 2)
Q1 Q2
Assumecurrent salesat Q2.
Margin of Safety
Margin ofsafety showshow far salescan fall beforelosses made. IfQ1 = 1000 andQ2 = 1800,sales could fall
by 800 unitsbefore a losswould bemade.
TR (p = 3)
Q3
A higher pricewould lower thebreak evenpoint and themargin of safetywould widen.
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Costs/Revenue
Output/Sales
FC
VC
TR
Eurotunnels problemHigh initial FC.Interest on debt
rises each year FCrise therefore.
FC 1
Losses get bigger!
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Break Even AnalysisBreak Even Analysis
Remember:
A higher price or lower price does notmean that break even will never bereached!
The break even point depends on thenumber of sales needed to generate
revenue to cover costs the break evenchart is NOT time related!
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Break Even AnalysisBreak Even Analysis
Importance ofPrice Elasticityof Demand:
Higher prices might mean fewer salesto break even but those sales may takea longer time to achieve
Lower prices might encourage morecustomers but higher volume neededbefore sufficient revenue generatedto break even
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Break Even AnalysisBreak Even Analysis
Links of break even to pricingstrategies and elasticity
Penetration pricing high volume,
low price more sales to break even Market Skimming high price low
volumes fewer sales to break even
Elasticity what is likely to happento sales when prices are increasedor decreased?
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BudgetsBudgets
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BudgetsBudgets
Estimates of the income andexpenditure of a business or a partof a business over a time period
Used extensively in planning Helps establish efficient use
of resources Help monitor cash flow and identify
departures from plans Maintains a focus and discipline
for those involved
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BudgetsBudgets
Flexible Budgets budgets that takeaccount of changing business conditions
Operating Budgets based on
the daily operations of a business Objectives Based Budgets - Budgets
driven by objectives set by the firm
Capital Budgets Plans of the
relationship between capital spendingand liquidity (cash) in the business
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BudgetsBudgets
Variance the difference betweenplanned values and actual values Positive variance actual figures less
than planned
Negative variance actual figuresabove planned
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