Types of Costs
Cost vs. Price
- Cost: The expenditure incurred by a business to produce a product or service.
- Price: The amount paid by a customer to purchase a product or service.
- Types of Costs
- Set-up Costs: Expenses for starting a business, like premises, equipment, and utilities.
- Running Costs: Ongoing expenses for operating a business, such as wages, insurance, and inventory.
Cost Categories:
- Fixed Costs: Costs that remain constant regardless of production or sales levels. Examples include rent, interest, advertising, and salaries.
- Variable Costs: Costs that change in proportion to production or sales levels. Examples include materials, labor, and packaging.
- Direct Costs: Costs directly attributable to producing a specific product or service.
- Indirect (Overhead) Costs: Costs that cannot be directly traced to a specific product or service.
Fixed Costs
- Fixed costs are expenses that a business must pay regardless of how much it produces or sells. These costs remain constant, even if there is no output.
Examples of fixed costs include:
- Rent for leased premises
- Interest payments on loans
- Advertising and marketing expenses
- Market research costs
- Management salaries
- Office supplies
- Security fees
- Professional fees
Key points about fixed costs:
- They are independent of production or sales levels.
- They can change over time due to factors like inflation or market conditions.
- Changes in fixed costs are not directly linked to the level of output or sales.
Variable Costs
- Variable costs are costs that change in direct proportion to the level of output or sales. As production increases, so do variable costs.
Examples of variable costs include:
- Raw materials
- Sales commissions
- Hourly wages
- Packaging costs
Total Costs
- Total Costs (TC) are the sum of fixed costs (FC) and variable costs (VC).
- Mathematically, TC = TVC + TFC.
- The TC line starts at the same point as the FC line on a graph, as fixed costs are incurred even with zero output.
- The difference between the TC and TVC lines at any output level represents the fixed costs.
Direct Costs
Direct costs are expenses that can be directly traced to a specific product or project. Unlike variable costs, they are not necessarily linked to the level of output.
Examples of direct costs include:
- Consultancy fees
- Legal fees
- Telephone bills
- Postage
- Photocopying costs
- Bank charges
Key points about direct costs:
- They are directly related to a specific product or project.
- They can be fixed or variable costs.
- They are traceable to a specific cost center.
Example:
- Catering costs for a mainstream airline might be considered variable as they increase with passenger numbers.
- Catering costs for a budget airline might be considered direct as they are directly related to the flight, regardless of passenger demand.
Indirect Costs
Indirect costs (also known as overheads) are expenses that cannot be directly linked to the production or sale of a specific product or service. They are costs that benefit the overall business but are not easily traceable to individual outputs.
Examples of indirect costs include:
- Rent
- Lighting
- Advertising
- Legal expenses
- Administrative salaries
- Insurance
- Security
- Office supplies
- Shipping and postage
- Utility bills
- Accounting fees
Revenue
- Revenue is the money a business earns, primarily from selling goods or services. It is calculated by multiplying the price of a product by the quantity sold.
- Formula:
- Sales revenue = Price x Quantity sold
Streams of Revenue
- Revenue streams are the various ways a business generates income, not just from selling goods or services.
Examples of revenue streams:
- Sales revenue: Income from selling goods or services (price x quantity)
- Advertising revenue: Businesses like Google earn money by displaying ads based on cost-per-click or impressions.
- Transaction fees: Budget airlines charge fees for checked baggage, seat selection, etc.
- Franchise fees and royalties: Franchises pay fees to the franchisor, and copyright holders earn royalties from their creations.
- Sponsorship revenue: Businesses pay to have their brand associated with an organization or event.
- Subscription fees: Customers pay a recurring fee for access to a service (e.g., gym memberships)
- Merchandise: Selling branded products alongside core services (e.g., sports team jerseys)
- Donations: Gifts from individuals or organizations (charities rely heavily on donations)
- Interest earnings: Businesses with large cash balances may earn interest on deposits.
- Dividends: Owning shares in other companies may generate dividend income.
- Subventions: Government financial support to reduce production costs (e.g., private schools)
