Costs and revenues
From WikiTextbook
When businesses are planning to produce a new product it is important that they work out the costs involved and the revenue they will probably make from selling the product. Businesses will identify costs that they have to pay before they open, known as start up costs, and those they will have to pay after opening, known as running costs. These costs are likely to be of a different type for manufacturing, retailing and service businesses.
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Start Up Costs
Start up costs are those costs that a business must pay before it can open, examples of these include paying for market research and buying premises, machinery and fixtures and fittings.
Running Costs
Running costs are those costs that a business must pay once it has opened, for example, advertising the product, paying rent on the premises, paying for power to run the machinery, paying government taxes on sales and paying for raw materials and workers’ wages. There is a difference between fixed and variable costs.
Fixed costs are those that have to be paid no matter how much the business produces. In fact the business still has to pay its fixed costs even if it doesn’t produce anything. An example of a fixed cost is rent; Pizza Hut will have to pay the same rent for its restaurant if it sells 1000 or no pizzas a night. Other examples of fixed costs are business rates and interest charges on loans. We can show the level of fixed costs for Pizza Hut on the diagram below. Their fixed costs are shown as a straight horizontal line at £5,000, this shows Pizza Hut will have to pay £5,000 per week no matter how many pizzas they sell.
Variable costs increase as output increases. This is because Pizza Hut will have to spend more money if they want to produce more pizzas, for example, if Pizza Hut doubled the number of pizzas they sold you would expect their costs to go up. The ingredients used to make pizzas are an example of a variable cost; this is because Pizza Hut will have to buy more ingredients if they want to sell more pizzas. Other examples of variable costs are delivery costs and chefs’ wages. Variable costs are shown as an upward sloping line; this shows that as the number of pizzas sold increases so do the variable costs.
Fixed and variable costs are a simple way of splitting up the different types of cost. However it can be more difficult to decide whether some costs are either fixed or variable. Are the mopeds Pizza Hut use for delivery a fixed or variable cost? You could argue that they are a fixed cost because Pizza Hut have to pay the tax and insurance on them no matter how may deliveries they make. You could also argue that they are a variable cost because the more deliveries Pizza Hut make the more petrol the mopeds will use. To get over this problem we would call the moped a semi-variable cost, in other words part of it is fixed and part of it is variable.
Total costs are equal to fixed plus variable costs. We can show fixed costs on the diagram below. Note that the total costs line doesn’t start from the origin (0) because of the fixed costs the business has to pay when output is zero.
Manufacturing, Retailing and Service Businesses
Each of these types of business will face different costs. It is possible for us to make generalisations about the types of costs that each will face.
Manufacturing businesses will normally have a lot of machinery. Machinery can be very expensive to buy therefore manufacturing businesses will often have high start up costs. Machinery is relatively cheap to run as it doesn’t have to be paid wages, therefore manufacturing businesses will often have relatively low running costs.
It will be the opposite for service sector businesses. Their start up costs will be relatively small as very little machinery is needed. However their running costs are likely to be more expensive as service sector businesses often need lots of employees to make sure that customers are satisfied.
Retailing businesses tend to be somewhere in between. They have average start up and running costs.
These examples for manufacturing, retailing and service sector businesses are of course examples. There will be businesses that find themselves in the opposite situation to the ones we have described, for example a manufacturing business with very low start up costs. It is therefore important to analyse each and every business carefully rather than simply look at which sector it is in.
The Role Played by ICT in Helping to Reduce Costs
Information and communications technology (ICT) means the computer hardware and software that is used to handle, analyse and communicate business data. The main software packages used are databases, word processors and spreadsheets. There are many different areas that ICT have helped to reduce costs.
STOCK CONTROL AND SERVING CUSTOMERS
Many modern stock control systems make use of bar coded information that is then scanned in to computers. This ensures that the computer knows exactly which products have entered and left the stock room. Retailers will often use the EFTPOS (Electronic funds transfer at point of Sale) system at their tills. EFTPOS scans bar codes and allows staff to serve many more customers as it is much quicker than entering the price of every item purchased. The EPOS system will help businesses such as Tesco to lower their costs as they will need fewer staff to work on the tills. In addition to this benefit EFTPOS is used to record exactly what has been sold, which allows up to date stock records to be kept. This data can assist in the decision of how much to order and when to order. This can help to lower costs as there will be less wastage in the stock room. It is possible for Tesco to set up an electronic data interchange (EDI), this is a permanent electronic link with the suppliers that can automatically re-order stocks. Again this will lower costs as Tesco will not need to employ staff to process all of the paperwork that is involved in the ordering of goods as computers will do it automatically.
All of the information about stocks could be held in a database. Tesco can then use this information to produce a printout of the stock in order of age, this is known as an aged stock analysis. This can help the manager to make decisions about future prices; he/she can make price reductions on any products that have been in stock for too long and try and sell them before they go out of date and have to be thrown away. The aged stock analysis can also help the manager to make decisions about future stock purchases; he/she can reduce the orders for goods if there are already lots of others that have been lying around for a long time. Again these will help the business to reduce costs as there will be less wastage.
CREDIT CONTROL
The business can make a database of all of its customers that owe it money. Using this information an aged debtor analysis can be produced. This will put customers in order of how long they have been in debt to the business. It can also provide the business with information about how much each customer owes and how long it has taken them to pay in the past. This will allow the business to reduce their costs as they could concentrate their efforts on the customers who owe a lot of money and have taken a long time to pay in the past.
MARKETING
Databases can provide businesses with up to date mailing lists that can be used to send information directly to its customers. Letters can be personalised and sent out in groups to people with similar characteristics. Tesco produce their customer database using the information they get from club card applications. The database will also contain information about what each customer buys when they visit the store using information taken from the EFTPOS system. Marketing campaigns can then be specifically targeted at groups with certain spending patterns, for example, if Tesco were to hold a wine tasting evening they would only send an invitation to customers who have a record of purchasing wine on the database. This will reduce Tesco’s costs as they won’t waste money by sending letters to those who do not buy wine.
PERSONNEL MANAGEMENT
Databases can be used to keep staff records. These records can then be used to help the Human Resources function to calculate basic pay, tax, national insurance, pension contributions and bonuses. This will reduce costs as fewer workers will be needed in the Human Resources function as computer will be able to do most of the paper work and calculations.
Further information about the workers’ level of sales, number of days off and lateness can be held on the database. This may help the business to reduce costs as the Human Resources manager can identify workers that are not working very hard.
FINANCE
Information about the business’s costs and revenues could be held on a spreadsheet. This can be manipulated to automatically produce profit/loss accounts, balance sheets, cash flow forecasts and budgets. This will save a great deal of time for the business leading to cost savings.
COMMUNICATION
Businesses are now able to communicate much quicker and cheaper thanks to ICT, for example, hundreds of e-mails can be sent for the fraction of the cost of one letter and video conferencing means that managers can speak face to face without having to travel long distances.
