1.6b Basic Financial Terms

Investors will want to see a prediction of profits. You need to understand these terms:

Revenue
Fixed Costs
Variable Costs
Total Costs
Profit

Revenue

Revenue is what a business earns, usually from selling goods / services. It does not take into account what the business has spent, it is just the sales amount.

Formula for calculating revenue:

Revenue (£) = Number of sales x Selling price

Costs

Revenue is not profit — a business has costs to pay. These must be subtracted from revenue to find out how much profit or loss a business has made.

There are two types of cost: fixed and variable.

Fixed Costs

These stay the same regardless of how much the business outputs.
Example: the building’s rent will be the same each month. It does not matter if the factory produces millions of products, or none!

Variable Costs

These change according to how much the business outputs.
Example: If the factory makes more teddy bears, it will need to buy more materials. If it makes less teddy bears, it will not need to buy as much materials.

Calculating Variable costs

The total number of units produced is multiplied by the cost spend producing them (inluding manufacturing, marketing, packaging, and distribution.

Variable costs = Units made x Cost per unit

Total Costs

The business’s fixed costs and variable costs are added together to give its total costs.

Total costs = Fixed costs + Variable costs

Example: In a month, a business's fixed costs are £4000 for wages, £1000 for electricity, and £500 for rent.

Fixed costs = £4000 + £1000 + £500 = £5500

It manufactures 2,000 teddy bears. The cost of materials and packaging is £3 per bear.

Variable costs = 2,000 x £3 = £6,000

The fixed and variable costs are added together to give the business's total costs:

Total costs = £5,500 x £6,000 = £11,500

Profit

Profit is the difference between how much a business earns (revenue) and how much it spends (its costs).

Profit = Revenue - Total Costs

If profit is a negative number, the business is making a loss.
If a business makes losses, it will run out of money and will fail.

Example: Let's look again at the teddy bear factory. It manages to sell all 2,000 teddy bears for £10 each.

Revenue = 2,000 x £10 = £20,000

Total costs = £11,500

Profit = £20,000 - £11,500 = £8,500

Therefore, the business made £8,500 profit.

Exam tip: Always write out the formula and show your calculations. You may get marks for them, even if your answer is wrong.