2.2.2 Sales, Revenue and Costs

Sales, Revenue and Costs

Key Definitions:

Revenue: The value of total sales made by a business within a given time period, typically a year.

Costs: The expenses incurred by a firm in the production and sale of products, such as staff wages and raw materials. 

Sales Volume: The number of units sold in a given time period, typically a year. 

Fixed Costs: A cost that does not change depending on the change in the number of sales, such as rent or staff salaries. 

Variable Costs: A cost that changes depending on the change in the number of sales, such as the cost of buying raw materials.

Total Variable Costs: The total of the variable costs involved with producing a specific output level, calculated by multiplying the variable cost per unit by the number of units sold. 

Total Costs: The total costs of producing a specific output level - this is the fixed costs added to the total variable costs. 

Piece-Rate Labour: When workers are paid per item they make instead of on a set hourly rate, which comes without being given regular pay. 

Sales

There are 2 ways to measure the sales of a business: by the volume and by the revenue. Sales volume is the number of units sold by the business. Sales revenue is the money earned by selling those products. For companies it is easy to calculate the sales volume, however calculating the sales revenue could be more difficult. Many products are now sold on credit so even though the item is sold, there is an element of uncertainty until the payment is received. 

Business Revenues

The revenue received by a business as a result of its trading activities is a huge factor in its success. An entrepreneur will start their financial planning by assessing the revenue they are likely to receive during the coming financial year. A business looking to increase its revenue can plan to sell more of their products or aim to sell them at a higher price. Some businesses may keep a higher price on their products even though this can reduce their sales - these companies believe that this approach will lead to higher profits and revenue in the long term. 

The other way to boost revenue is to charge a low price in an attempt to sell more units. The higher sales volumes may lead to higher revenues and profits. Firms following this approach are likely to be operating in markets with more similar goods so consumers do not exhibit strong preferences for any particular brand. Price competition in these markets tend to be higher as businesses will compete to maximize their revenue gains. 

Traditionally companies printed price lists that may run for a year (12 months). Nowadays this has changed as online shopping makes variable pricing more common by allowing prices to rise and fall depending on the demand and supply conditions. This is a way to maximize revenue through charging higher prices when demand is higher, but lowering prices when the demand for products is lower. 

The Costs of Production

Costs are a critical element of the information necessary to successfully manage a business, Managers need to be aware of the costs of all aspects of the business for multiple reasons:

• They need to know the cost of production to assess whether it is profitable to supply the market at the current price.
  
• They need to know actual costs to make comparisons with forecasted or budgeted figures. This will allow them to make judgements concerning the cost efficiency of different parts of the business. 

Fixed and Variable Costs

These costs are very important to the business as they have a number of uses. One use for these costs is the use of these costs in calculating the break even points.

Fixed Costs

These are any cost that do not vary directly with the level of output in the business. These costs are linked to time instead of level of business activity, and they exist even if there are no goods being produced by the business. These include rent, bills, salaries and wages, and interest charges. In the long term fixed costs can change. The manufacturer could increase their output significantly leading to a need to rent additional factory space and the negotiation of loans for additional capital equipment. The rent will, as a result, increase alongside interest payments. 

On a break even graph the fixed costs are represented as a straight, horizontal line. 

Variable Costs

These are the costs that vary directly with the level of output of the business. They represent the payments made for the labour, fuel and raw materials needed for the production of the goods. If a manufacturer doubled their output then their variable costs would also double. Many small businesses may find that variable costs do not increase as quickly as their output increases as the business grows. A key reason behind this is the fact that as the business get larger they become able to negotiate better prices for their materials as they place larger orders. 

On a break even graph the variable costs are shown as a diagonal line - however this depends on whether the increase in costs are proportionate or not. If they are proportionate then the line is constantly diagonal as costs increase at the same rate. If not, then the line could become curved and fluctuate as costs change. 

Total Costs

When added together the fixed and variable costs give the total costs for the business. This is crucial in the calculation of the profits earned by a business. If a business has relatively high fixed costs then they are likely to want to maximize sales in order to ensure the fixed costs are spread over as many units of output as possible. By doing this they are reducing the impact of the higher fixed costs.