Costs and Revenues
Classifying business costs and understanding how revenue is generated.
- Classify costs as fixed or variable, and as direct or indirect
- Calculate total costs, total revenue, and profit given output data
- Explain the difference between contribution and profit
Types of Cost
Costs can be classified in two ways: by their behaviour (fixed vs variable) or by how they relate to the product (direct vs indirect).
Fixed Costs
Costs that do not change with the level of output in the short run. Whether the business produces 10 units or 10,000, these costs remain the same.
Examples: rent, insurance, management salaries, loan interest payments.
Variable Costs
Costs that change directly with the level of output. The more you produce, the higher the total variable cost.
Examples: raw materials, direct labour (if paid per unit), packaging, piece-rate wages.
Direct Costs
Costs that can be directly attributed to a specific product, department, or cost centre. Also called "prime costs."
Examples: ingredients in a recipe, fabric in a garment, labour directly assembling a product.
Indirect Costs / Overhead
Costs that cannot be easily attributed to a single product or cost centre — they support the whole business. Also called "overheads."
Examples: head office rent, administrative salaries, marketing campaigns for the whole brand.
These classifications are not mutually exclusive. A cost can be both variable and direct (e.g. raw materials per unit), or both fixed and indirect (e.g. office rent). The two sets of categories cut across each other.
| Fixed | Variable | |
|---|---|---|
| Changes with output? | No | Yes |
| Example | Rent, insurance | Raw materials, packaging |
| On break-even chart | Horizontal line | Rises with output (part of total costs) |
Be careful with labour: it can be either fixed (salaried managers) or variable (hourly workers or piece-rate). Always read the context carefully before classifying.
Total Costs
Revenue
Total revenue is the total income received by a business from selling goods or services. It is calculated before any costs are deducted.
Revenue Streams
A revenue stream is a distinct source of income. Modern businesses often have multiple revenue streams to diversify income and reduce dependence on a single source.
| Revenue Stream | Description | Example |
|---|---|---|
| Product sales | One-time sale of a physical product | Selling a smartphone |
| Service fees | Charging for a service delivered | Consulting, haircuts |
| Subscription | Recurring fee for ongoing access | Netflix, gym membership |
| Licensing | Others pay to use your intellectual property | Software licences, franchises |
| Advertising | Income from selling ad space | Google, newspapers |
| Commission | Percentage of a transaction value | Estate agents, Airbnb |
| Rental income | Charging others to use an owned asset | Property rental |
Key Terms
- Fixed costs don't change with output; variable costs do
- Direct costs are traceable to a product; indirect costs are shared overheads
- Total costs = fixed costs + (variable cost per unit × quantity)
- Total revenue = price × quantity sold
- Businesses may have multiple revenue streams to reduce risk
• Factory rent: $8,000
• Fabric (per unit): $12
• Manager salary: $4,500
• Buttons/thread (per unit): $0.80
(a) Identify which costs are fixed and which are variable.
(b) Calculate total costs if the business produces 500 units in a month. [6 marks]
Show answer
(a)
- Factory rent: Fixed
- Fabric per unit: Variable
- Manager salary: Fixed
- Buttons/thread per unit: Variable
(b)
Total Fixed Costs = $8,000 + $4,500 = $12,500
Variable cost per unit = $12 + $0.80 = $12.80
Total Variable Costs = $12.80 × 500 = $6,400
Total Costs = $12,500 + $6,400 = $18,900
Common mistake: Multiplying fixed costs by output. Fixed costs stay constant regardless of units produced — only variable costs scale with output. If you find yourself multiplying rent by 500, stop and reconsider.
(a) Calculate total weekly revenue.
(b) If variable costs are $1.20 per cup and fixed costs are $1,800 per week, calculate profit or loss. [4 marks]
Show answer
(a) Total Revenue = $4.50 × 800 = $3,600
(b) Total Variable Costs = $1.20 × 800 = $960
Total Costs = $960 + $1,800 = $2,760
Profit = $3,600 − $2,760 = $840 profit
Common mistake: Adding fixed and variable costs per unit before multiplying. You must calculate total variable costs first (VC per unit × output), then add total fixed costs — not add per-unit figures and multiply the whole lot.
Show answer
A direct cost can be specifically attributed to the production of a particular good or service. For example, the ingredients used to make a pizza are a direct cost of that pizza.
An indirect cost (overhead) cannot be easily linked to a single product — it supports the whole business. For example, the electricity bill for the whole restaurant is shared across all products and cannot be attributed to a single pizza.
Common mistake: Confusing the fixed/variable distinction with direct/indirect. These are two separate classifications. A cost can be variable AND indirect (e.g. utilities that fluctuate with production but serve the whole factory), or fixed AND direct (e.g. a machine leased specifically for one product line).