Fixed, Variable & Total Costs | Business Costs

Summary

This video explains the importance of understanding business costs, focusing on fixed and variable expenses and how to calculate total costs. Variable costs, like raw materials, increase with production, while fixed costs, such as rent and salaries, remain constant regardless of output. Using an example of Tom’s T-shirt business, the video demonstrates how to calculate total monthly costs by adding total variable and fixed costs. Knowing total costs helps businesses set prices that cover expenses and achieve profitability, enabling more informed financial decisions.

Takeaways

• 💼 Knowing the costs involved in running a business is crucial to determining profit or loss.
• 📊 Costs can be divided into two categories: variable costs and fixed costs.
• 📈 Variable costs increase with the level of output. More production leads to higher variable costs.
• 👕 An example of a variable cost is raw materials like cotton in the production of t-shirts.
• 🔢 To calculate total variable costs, multiply the cost per unit by the number of units produced.
• 🏠 Fixed costs, such as rent, salaries, and insurance, remain constant regardless of output level.
• 💷 Tom’s fixed costs include £500 for rent, £1,200 in salary, and £200 in insurance, totaling £1,900 per month.
• 💡 Total costs are calculated by adding total variable costs and total fixed costs.
• ⚖️ Knowing total costs helps businesses set appropriate prices to cover costs and make a profit.
• 📉 Without knowing total costs, businesses may set prices too low and risk making a loss.

Q & A

What are the two main types of costs a business incurs?

The two main types of costs a business incurs are variable costs and fixed costs.

What are variable costs, and how do they behave in relation to business output?

Variable costs vary with the level of output, meaning that as the business produces more, the variable costs increase. For example, raw materials required to make a product are variable costs.

Can you provide an example of a variable cost?

An example of a variable cost is the raw materials needed to make a product. In the case of a t-shirt business, the cotton required to make the t-shirts is a variable cost, as the more t-shirts produced, the more cotton is needed.

How do you calculate the total variable cost of a business?

The total variable cost is calculated by multiplying the variable cost per unit by the number of units produced. For example, if the variable cost per t-shirt is £5, and 500 t-shirts are produced, the total variable cost is £5 × 500 = £2,500.

What are fixed costs, and how do they differ from variable costs?

Fixed costs remain constant regardless of the business’s level of output. These costs do not change whether the business produces a small or large number of products. Examples include rent, salaries, and insurance.

What are some examples of fixed costs in a business?

Examples of fixed costs include rent for storage, employee salaries, and insurance premiums. These costs do not fluctuate with the level of production.

How do you calculate the total fixed cost for a business?

The total fixed cost is calculated by adding up all fixed expenses. For example, if the rent is £500, salaries are £1,200, and insurance is £200, the total fixed cost is £500 + £1,200 + £200 = £1,900.

How is the total cost of a business calculated?

The total cost of a business is calculated by adding the total variable costs to the total fixed costs. For example, if the total variable cost is £2,500 and the total fixed cost is £1,900, the total cost is £2,500 + £1,900 = £4,400.

Why is it important for a business owner to know their total costs?

Knowing total costs is important because it helps a business owner understand how much they need to make in revenue to break even and set prices that allow the business to make a profit. Without this information, they risk making a loss.

How can a business owner use total cost information to set prices for their products?

A business owner can use total cost information to ensure the price of their products covers both fixed and variable costs. For example, if the total cost for a month is £4,400 and the business can produce 500 units, the price per unit needs to be high enough to cover these costs and generate profit.