Levon Gzokyan ● Business & English ● Unit 4

‘WARM-UP’ POINT

One of the aims of businesses is to make a profit. However, all business activity costs money. Business costs include:

• raw materials and components

• wages and salaries

• electricity and power

• factory and office costs, including rent

• market research, advertising, postage and telephone charges, and other costs

T o cover these costs, the business sells the goods or services it produces. The money the business receives in return is its income or revenue. If the revenue is more than costs, it has made a profit. If the revenue is less than costs, it has made a loss. If the revenue equals to costs, it has broken even. The chart below represents the concept of profit and loss.

The costs of each of the companies from the chart above add up to $50,000 a year.

►Which company has made a loss, which has made a profit and which has broken even?

To find out whether or not it is going to make a profit, a company needs to calculate the costs of producing the product and the revenue it will receive form selling the product. The costs of a business fall into two areas:

• start-up costs

• running costs

►Fill in the empty boxes in the figure below with examples of start-up and running costs.

‘MAKE YOUR’ POINT

►In each case, make a list of the start-up costs that will be incurred before any revenue is received.

1. Irina Ryzhankova wants to open her own small coffee shop in Moscow State University campus. She is planning to provide a wide range of morning coffee, light lunches, including vegetarian menu, and afternoon teas satisfying the most exquisite tastes for university faculty, students and employees, and other people working locally. Although Irina is sure that she can afford to undertake this project, her finances are limited, so she wants to know what her start-up costs are going to be.

2. Krosby, a breakfast cereal producing company, is planning to produce a new sort of corn flakes to respond to changing consumer requirements. Recently the number of consumers requiring low calorie and fat free cereals is sky rocketing. The nutritional value is thus becoming of major concern. What are the principal start-up costs that Krosby is going to incur?

3. When Katya Yefimova was made redundant from her job, her friend Dima suggested that she open a flower shop. Dima has a restaurant in Moscow, and also does some catering at local offices. He constantly requires fresh flowers and arrangements and, knowing Katya’s interest in flowers and gardening, thought this might be a good way to help them both. There was a vacant shop not far from Dima’s restaurant that would be convenient. Katya liked the idea of owning a flower shop. The only source of capital is her personal savings. No opportunity to get a bank loan. Thus identifying the start-up costs is critical. What will these costs include?

►Now make a list of the types of running costs that will be incurred by each of these businesses.

‘PUZZLE-1’ POINT

►The figure below represents the costs incurred and revenue generated by three businesses involved in sports – a football club, a sports goods manufacturer and a sports store. Use your knowledge and observations to:

• fill in the empty arrows with the costs or revenues assumed

• explain the business activities involved and their interrelations

‘THEORY-1’ POINT

Breakeven point

(1) The breakeven point of a new product is the level of production and sales at which costs and revenues are equal. It is the point at which revenue exactly covers costs and there is no profit or loss. To calculate the breakeven point we must distinguish between variable and fixed costs.

• Variable costs are those that are directly related to production. They are called variable costs because they vary directly with the level of production. The more units of a product are produced, the more raw materials are used and the higher their overall cost.

• Fixed costs are those that are involved in the running of the business but not in the actual production of the product. Fixed costs do not vary with the level of production. They are sometimes called overheads, and are costs that must be paid even if nothing is produced at all.

(2) In addition to these costs, we must calculate the revenue that will be generated from any given level of production and sales of the product. In order to do this, we have to know the product’s price which is then multiplied by the number of units produced.

(3) When we calculate the breakeven point, we keep in mind that two elements are built into the price of the product. The first part covers the fixed costs of the business; the second part covers variable costs of producing one unit of the product.

( 4) The part of the price that covers the fixed costs is called the contribution, since it contributes towards the fixed costs. As soon as we have produced enough units to cover the fixed costs, - in other words, we have reached the breakeven point, - the contribution from each additional unit sold goes towards the profit of our business. Let’s visualize the process.

(5) Imagine you want to extract juice from a dozen of apples. You put the apples into the feeding tube and have a glass filled with apple juice. Now imagine the glass is labeled ‘fixed costs’. Each drop of juice into the glass is a contribution. Drop by drop you are having the glass filled with contributions. As soon as it is full of juice or contributions, your fixed costs are covered, and from this time on you can enjoy the profit of your business.

(6) The breakeven point can be calculated this way:

The breakeven point is therefore the number of contributions required to cover the fixed costs of your business.

►Question/Answer session:

1. Define the breakeven point, variable costs and fixed costs.

2. How is the breakeven points calculated? Visualize your answer with another example.

‘PUZZLE-2’ POINT

Suppose you want to celebrate the graduation day. You are planning a concert, which requires some fixed costs such as payment for flowers and balloons to decorate the stage, the costs of the hall, props, posters and printing tickets. It is important that you cover the costs of the concert which amount to $1,000. You are going to have a little gift set costing $10 per head included in the ticket price. This is the variable cost of the concert. Asking around, you feel that tickets should be priced at $20.

►Calculate the breakeven point and say how many tickets you must sell to break even.

But you also want to make a donation of $500 to SPA Student Union Fund. Therefore it must be included in your calculations.

►Calculate new breakeven point.

This point shows that you must sell … (how many?) tickets to cover the costs and make the donation. Now you can use this info to decide whether to proceed with the celebration day concert. The question you have to answer is: can I sell … tickets at $20 each? What should you do if you feel that you cannot?

‘THEORY-2’ POINT