Business Costs (OCR GCSE Business)

An Introduction to Business Costs

• In preparing goods and services for sale, businesses incur a range of costs

  • Some examples of these costs include purchasing raw materials, paying staff salaries and wages, and paying utility bills such as electricity  

• These costs can be broken into different categories:

  • Fixed costs

  • Variable costs

  • Total costs

Fixed Costs

• Fixed costs are costs that do not change as the level of output changes

Diagram: fixed costs

• Fixed costs have to be paid, even if a business does not produce any output

  • Examples include rent, management salaries, insurance and bank loan repayments

Variable Costs

• Variable costs are directly linked to output

• These increase as output increases, and vice versa

  • Examples include raw material costs and the wages of workers directly involved in production and packaging

Diagram: variable costs

• Total variable costs at a particular level of output are calculated using the formula:

Total Costs

• Total costs are the sum of the fixed and variable costs at a particular level of output

Diagram: total costs

• Total costs at a particular level of output are calculated using the formula:

Ways to Reduce Costs

• Businesses often look to reduce costs as a way to improve profitability

Reduce fixed costs

• Reducing staffing levels, relocating to cheaper premises or changing utility companies or other suppliers can reduce fixed costs

  • Reducing staffing levels may affect staff morale and negatively affect productivity

  • Relocation costs can outweigh some of the benefits of moving to a cheaper location

  • Replacing inefficient or outdated equipment may require staff training

Reduce variable costs 

• This may involve purchasing cheaper/alternative resources, negotiating with suppliers or purchasing in bulk

  • Businesses must ensure that reducing variable costs does not have an adverse effect on the quality of products

  • Buying stock in greater quantities may require investment in increased storage space, which reduces the impact of the cost savings made

  • Businesses may also be able to reduce wastage of raw materials and components 

Reduce one-off costs and interest charges 

• Delaying the purchase of fixed assets, entering leasing arrangements, or restructuring borrowing can reduce costs 

  • Delaying purchases of new fixed assets, such as machinery or vehicles, may lead to increased breakdowns and maintenance of the old equipment

  • The leasing  of equipment (e.g. photocopiers) can reduce one-off purchase costs but the business never owns these assets

  • Restructuring loans can result in lower monthly payments, but it also requires lenders to agree to new lending terms, which they may not be willing to do