What is cost and revenue in economics?, Types of cost, Revenue calculation formula.

Cost and Revenue in economics

Cost and revenue are the two most important terms in business economics. The target of every business is to minimize the cost and maximize the revenue so that the business makes the maximum profit.
 
Now let me explain, each term separately-

What is Cost?

Cost is the monetary value that every business has spent to produce some product and service.
what is cost and revenue
Cost
In every business, the cost is the monetary valuation of raw materials, time, effort, and other resources that are used to make the product.
In this case, money is the input of the production system in order to acquire the desire product or services. During business planning for a company, project, or product it is important to estimate the cost in order to ensure profit.

Types of cost

Costs are usually classified according to their relationship with the level of output of the firm. Different types of costs are there, some important types are-
  • Direct cost,
  • Indirect cost.
  • Fixed cost,
  • Variable cost,
  • Semi-variable cost.

Direct cost

Direct costs are those costs that are directly involved with the manufacturing of the product. Direct costs include raw material cost, cost related to workers, etc.
 
Direct cost is dived into three categories,
1. Direct Materials cost:
Direct materials cost is the cost of raw materials that are directly involved with the unit of production. It is a variable cost involved in the production process.
Examples of direct materials are – The timber used during house construction, the steel used in an automobile, the Circuit board included in electronic devices, the cost of steel is the direct material cost in nut-boult manufacturing, etc.
 
2. Direct labour cost:
Direct labour cost is the cost of work done by the workers, who actually make the product in the production line.

Direct labour costs are generally associated with the products In a job costing environment,  the production staff is keeping record of their working hour. In service industries, direct labor cost is associated with consulting, tax preparation, auditing, etc where employees measure their working hours by the number of jobs so that employers can bill customers based on the direct labour cost.
 
3. Manufacturing overhead cost:
Manufacturing overhead cost is the cost of indirect materials such as lubricant, indirect labour such as maintenance labour, cleaning labour, rent, insurance, compensation of plant managers, property taxes, etc.


Indirect cost

Indirect costs are not directly involved with the manufacturing of a product.  Examples of indirect costs are the salary of sales personnel, advertising cost, cost of rags, and solvents used during house construction, the grease used on machinery, etc.
 
There are two types of indirect cost-

 

1. Selling and distribution costs:
Selling and distribution costs involve salary, the incentive of sales personnel, and distribution costs like commission or salary of the distributor, advertising cost, etc. Selling and distribution costs are categorized as Indirect costs because they are not directly involved during production. Some components are changed with the change of sale volume, While other components remain the same. That’s why it is a semi-variable cost.

 

selling cost
Selling cost
2. Administrative costs:
Administrative costs are known as fixed cost or overhead cost, these costs are not directly affected by manufacturing or sales volume, therefore the administrative cost is known as a fixed cost. 
Administrative costs include the salary of leadership and managers, accountant, project managers, etc.

 

Administrative cost
Administrative cost

Fixed Cost

Fixed cost does not change with an increase or decrease in the number of goods or services produced or sold. Fixed costs are expenses that must be paid by a company. Fixes cost is independent of any specific business activities and does not change with the production level.

Fixed costs are direct or indirect expenses and therefore they may influence profitability at different points along with the income statement.

Examples of Fixed cost are,
  • Rent
  • Office salaries
  • Advertising
  • Insurance
  • Depreciation, etc.

Variable Cost

Variable costs are a corporate expense that changes in proportion to production output. Variable costs increase or decrease depending on a company’s production volume, which means they rise as production increases and fall as production decreases.

Examples of variable costs are,
  • Direct labour
  • Raw materials and components
  • Packaging costs
  • Royalties

Semi-variable Cost

In reality, we cannot classify every cost as fixed or variable costs, In that case, we classify these types of cost as semi-variable cost.

Semi-variable cost is an expense, which includes a mixture of both the fixed and variable components. Semi-variable costs change with the output, but not in direct proportion, the fixed cost element is the part of the cost that must be paid irrespective of the level of activity.

These costs are sometimes called mixed costs. In some cases, costs may be fixed for a set level of production, and become variable after that level is exceeded.

Examples of Semi-variable cost are,
  • The wages of the production staff may appear to be variable costs, but they will vary with the level of output.
  • Telephone bills often contain a fixed-line rental charge, but call charges vary with the number of calls made in a month.

What is revenue?

Revenue is the total money generated by selling goods and services within a specific time, before dedicated any expenses.  It is the gross income figure from which costs are subtracted to determine the net income.
 
Revenue
Revenue
Revenue is also referred to as the turnover of a company. Some companies are generating revenue by normal business activities, selling products, etc.
On the other hand, some companies receive revenue from interest, royalties, etc.
The government receives tax revenue from taxpayers. An organization generates sales revenue by selling products over a time period.

Types of Revenue

 
A company’s revenue may be subdivided according to the divisions that generate the revenue. So, revenue can also divide by-
 
  • Operating revenue – generated by the sales from a company’s core business is called operating revenue. For example, a retailer produces its operating revenue through merchandise sales; a physician derives its operating revenue from the medical services that they provide. 
  • Non-operating revenue – This types of revenue is derived from secondary sources. As these non-operating revenue sources are often unpredictable and nonrecurring, they can be referred to as one-time events or gains of the company. For example, proceeds from the sale of an asset, a windfall from investments, or money awarded through litigation are non-operating revenue.
 
 

Operating expenses:

Operating expenses are the cost needed to run its normal business operations. Operating expenses are necessary for most businesses. 
 
Operating expenses include inventory cost, rent, marketing, equipment, insurance, research and development cost, etc.
Reduction in operating expenses means compromising product quality. so finding the perfect balance is difficult but can yield significant rewards.

Calculation of cost and revenue:

Cost can be calculated as-

 To calculate the Prime cost, add direct raw materials cost and direct labour costs together.

Prime cost=Direct raw materials + Direct labour

Factory Cost

Factory cost is the addition of Prime cost and factory overhead.

That means, Factory cost = Direct material cost +Direct labour cost+ direct expenses ( variable )+Factory overhead

Total cost

Total cost= Factory cost + Selling overhead + Distribution overhead + administration overhead.

Revenue can be calculated as –

 
Sales revenue = Price of goods x number of units sold.
 
(In revenue, we are not deducting any expenses associated with the manufacture of the product.)
Revenue does not give a clear picture of the success of a company. Net profit tells you about the success of a company.
 
Net profit = Revenue – expenses.
 

Break-even analysis

Break-even analysis entails calculating and examining the margin of safety for a business based on the collected revenues and associated costs. that means the analysis shows how many sales it takes to fully recover the cost of doing business. Analyzing different price levels relating to various levels of demand, the break-even analysis determines what level of sales are necessary to cover the company’s total fixed costs. A demand-side analysis would give a seller significant insight into selling capabilities.

Read more about break-even analysis…

Difference between cost and revenue

Cost is the monetary value that every business has spent to produce some product and service. In every business, the cost is the monetary valuation of raw materials, time, effort, and other resources that are used to make the product. In this case, money is the input of the production system in order to acquire the desire product or services.

On the other hand, Revenue is the total money generated by selling goods and services within a specific time, before dedicated any expenses. It is the gross income figure from which costs are subtracted to determine the net income.

Cost and revenue analysis

The cost and revenue analysis examines the cost of production and sales generated under various conditions.
 
The objective of a company is to earn a profit, without making a loss. However, profit or loss is primarily determined by its costs and revenue. In simple terms, profit/loss is defined as the difference between the total revenue and the total cost, that is Profit or Loss = Total Revenue – Total Cost.
 
So, we can conclude that cost and revenue both are a very important factor for an organization, where cost is the monetary value that every business has spent to produce some product and service, on the other hand, revenue is the total money generated by selling those goods and services.

Reference

 
 

4. https://www.investopedia.com/terms/b/breakevenanalysis.asp#:~:text=Break%2Deven%20analysis%20tells%20you,corporate%20budgeting%20for%20various%20projects.

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