Putting a Business Idea into Practice
Business revenues, costs and profits
Contents
Revenue is the money a business earns from selling its products over a period of time, such as a week, a month or a year. You may also see it called total revenue, sales revenue or turnover — all four terms mean the same thing. Only sales of goods or services count as revenue. Money from a loan or from the owner's savings is finance coming in, not revenue, because nothing has been sold to earn it.
Working out revenue
Revenue depends on two things: the price each product sells for and how many are sold. The formula is:
Revenue = selling price × quantity sold
For example, an online shop sells phone cases for £9 each and sells 300 in a month. Revenue is £9 × 300 = £2,700. If the owner raises the price to £12 and still sells 300 cases, revenue rises to £3,600, because each sale now brings in more money.
| Month | Selling price per phone case | Phone cases sold | Revenue |
|---|---|---|---|
| March | £9 | 300 | £2,700 |
| April | £7 | 450 | £3,150 |
The table shows why quantity matters as much as price: cutting the price to £7 still raised revenue in April, because far more phone cases were sold. Revenue is not the same as profit — it is the money taken from sales before any costs are deducted, so a business with high revenue can still make a loss if its costs are higher.
When nothing is sold
If a business makes no sales, its revenue is zero. On a break-even diagram, which plots revenue against output, the revenue line therefore starts at the origin (0, 0): no units sold means no money earned, and each extra unit sold adds the selling price to revenue.
Fixed costs do not change when the level of output changes. They stay the same whether output is 10 units or 10,000, and must be paid even if output falls to zero. A cinema paying a £2,400 yearly licence fee to show films pays the same in a quiet January as in a busy August. Business rates and the salary of a supervisor on a fixed contract are also fixed costs.
Variable costs change as output changes. They rise as more is produced and fall when production slows, because they are the costs of the things used up making each unit, such as fruit, bottles and labels for each smoothie, or staff paid for each item they produce. With no output, variable costs are zero: no smoothies blended means no fruit bought. To find total variable costs, multiply the variable cost of one unit by the quantity produced:
- Total variable costs = variable cost per unit × quantity of output
For example, a smoothie maker spends £0.80 on fruit and a bottle for each drink. Making 2,000 bottles gives total variable costs of 2,000 × £0.80 = £1,600. At 3,000 bottles the figure is £2,400, so the cost moves with output — that is what makes it variable.
Working out total costs
Total costs are the whole amount a business pays out over a period: its fixed costs plus its variable costs, so TC = TFC + TVC.
Suppose the smoothie maker has fixed costs of £5,000 a month and produces 2,000 bottles. Total variable costs are £1,600, so total costs are £5,000 + £1,600 = £6,600. At 4,000 bottles, fixed costs stay at £5,000 but variable costs rise to £3,200, giving total costs of £8,200. Even with no production, total costs equal the fixed costs, so they never fall to zero.
A cost is fixed or variable because of how it behaves when output changes, not because of what it is called: a delivery driver paid per parcel is a variable cost, while one on a yearly salary is fixed.
Break-even level of output is the number of units a business must sell for its total revenue to equal its total costs. At that output the business makes neither a profit nor a loss — profit is zero.
To find it in units, use:
Break-even point in units = fixed costs ÷ (selling price − variable cost per unit)
The bracket (selling price − variable cost per unit) is the money each sale contributes towards covering fixed costs. For example, a bike repair shop has fixed costs of £5,400 a month, charges £30 per repair and has variable costs of £12 per repair. Each repair adds £30 − £12 = £18 towards those fixed costs. Break-even = £5,400 ÷ £18 = 300 repairs.
To express break-even as revenue:
Break-even point in costs or revenue = break-even point in units × selling price
For the repair shop: 300 × £30 = £9,000. You can check this: at 300 repairs, total costs are £5,400 + (300 × £12) = £9,000, exactly the same as revenue.
Below break-even, total costs are greater than total revenue, so the business makes a loss. At 240 repairs, revenue is £7,200 but total costs are £8,280, so the loss is £1,080. Above break-even, revenue is greater than total costs, so the business makes a profit.
You need to learn the break-even formulae, along with the formulae for revenue, total costs, margin of safety and interest, because they are not given in the exam.
Margin of safety is the gap between the sales a business actually makes, or plans to make, and its break-even level of sales. You calculate it as:
Margin of safety = actual or budgeted sales − break-even sales
It shows how much sales can fall before the business reaches break-even. A large margin gives the business a cushion: sales could drop by that amount and it would still avoid a loss. A small margin means even a slight fall in sales could push it into loss.
Worked example
A mobile pet-grooming service has break-even sales of 480 appointments a year. It budgets for 620 appointments. Margin of safety = 620 − 480 = 140 appointments. The business could lose 140 appointments and still just break even. If it lost more than 140 appointments, it would make a loss.
Below break-even
If actual or budgeted sales are below break-even sales, the business is making a loss and has no positive margin of safety. For example, break-even sales of 480 appointments and actual sales of 430 gives 430 − 480 = −50. The negative figure shows the business is 50 appointments short of break-even; it is not a safety cushion. Margin of safety is the gap above break-even, not the break-even point itself.
A break-even diagram is a graph plotting a business's revenue and costs against the number of units it makes and sells. Money in pounds (both revenue and costs) goes on the vertical axis, and output or sales in units goes on the horizontal axis, showing where the business makes neither a profit nor a loss.
The lines on the diagram
Four lines are drawn, and each one behaves differently:
| Line | Where it starts | Shape |
|---|---|---|
| Total revenue | At the origin | Straight line rising with each sale |
| Fixed costs | At the fixed cost level | Horizontal, as fixed costs do not change with output |
| Variable costs | At the origin | Rises steadily, as no output means no variable costs |
| Total costs | At the fixed cost level | Parallel to the variable cost line, as total costs are fixed costs plus variable costs |
The vertical gap between the total cost line and the variable cost line always equals the fixed costs.
Reading profit and loss
The break-even point is where the total revenue line crosses the total cost line, so revenue equals total costs. Below the crossing, the total cost line sits above the revenue line, so the business makes a loss. Above it, revenue is higher, so the business makes a profit. The vertical gap between the two lines at any output is the size of that profit or loss.
For example, a T-shirt printer sells each shirt for £13, pays £4 variable cost per shirt and has fixed costs of £450 a month. At 30 shirts, revenue is £390 but total costs are £570, a loss of £180. At 50 shirts, both lines meet at £650. At 80 shirts, revenue is £1,040 against costs of £770, a profit of £270.
Why the diagram helps
- It shows the break-even output without any calculation.
- It shows the profit or loss at any level of output.
- The horizontal distance between planned sales and the break-even point is the margin of safety: how far sales could fall before losses begin.
- Managers use it to set sales targets and to monitor actual performance against the break-even plan.
On a break-even diagram, changing the selling price, variable cost per unit or fixed costs moves a line. Changing how many units you sell moves your actual sales along the horizontal axis. Both change the break-even point, the profit or loss at a given output and the margin of safety.
Selling price and quantity sold
If the selling price rises with costs unchanged, each sale brings in more money, so the revenue line becomes steeper and crosses the total cost line at a lower output. The break-even point falls and profit at a given output is higher. A lower selling price makes the revenue line less steep, raises the break-even point and reduces profit or increases loss.
Selling more units at the same price does not move the revenue line; it moves actual sales right. Revenue at that output is higher, so profit and the margin of safety can increase. Selling fewer units moves actual sales left, which can turn a profit into a loss and shrinks the margin of safety.
Fixed and variable costs
A higher variable cost per unit makes the total cost line steeper because costs rise faster with each unit made, so break-even rises and profit falls. A lower variable cost per unit flattens the line, lowering break-even and raising profit. Higher fixed costs shift the whole total cost line upward, so break-even is higher and profit lower; lower fixed costs shift it down and lower break-even.
Worked example
Poppy sells plant pots for £12 each. Fixed costs are £400 a month and variable cost is £4 a pot, so break-even is £400 ÷ (£12 − £4) = 50 pots. At 70 pots, revenue is £840 (70 × £12) and total costs are £680 (£400 + 70 × £4), so profit is £160 and the margin of safety is 20 pots. If the price rises to £14, break-even falls to 40 pots and profit at 70 pots rises to £300. If variable cost rises to £6, break-even rises to 67 pots and profit at 70 pots falls to £20. If fixed costs rise to £480, break-even becomes 60 pots and profit falls to £80.