Cost and Break Even Analysis Summary

Cost Analysis
Cost analysis is a process that involves the systematic examination and evaluation of the costs
associated with a particular project, business process, product or service.
Cost is divided into the following categories:
● Based on stakeholders
○ Explicit costs: These are expenses incurred to purchase or pay for external
factors, such as the price of raw materials, wages of labour and salary of
managers.
○ Implicit costs: An implicit cost is an expense that doesn’t involve a direct
monetary transaction and isn’t documented in financial records. For example, if
the biscuit factory is built on your land, you save the rent you would have paid if
the land belonged to someone else. This is a type of implicit cost.
● Based on traceability
○ Direct costs: These are the specific, traceable expenses that can be directly and
unequivocally attributed to a particular product, project, department or cost
centre. The cost of raw materials and labour wages are a few examples of direct
costs.
○ Indirect costs: These expenses cannot be directly attributed to a specific
product, project, department or cost centre. A few examples are rent, utilities and
supplies.
● Based on the nature
○ Material costs: They refer to the direct costs associated with the raw materials,
components or supplies used to manufacture a product or provide a service.
Expenses incurred in acquiring, transporting, storing and processing the
necessary materials are a few examples.
○ Labour costs: They refer to the total amount a business pays to its employees
for their work over a specific period, which is typically a month or a year.
Examples include expenses related to employees, like wages, salaries, benefits
and other related costs.
● Based on behaviour
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○ Fixed costs: These costs remain relatively constant regardless of changes in the
volume of goods or services produced. Some examples are depreciation and
property taxes.
○ Variable costs: These are expenses that change in direct proportion to the level
of production or the amount of sales. Raw materials, packaging materials and
direct labour costs are a few examples of these.
○ The following equation displays the relationship between fixed costs and variable
costs:
Total cost = Fixed costs + Variable costs
Cost Sheet
A cost sheet is a structured document that provides a detailed breakdown of various costs
associated with the production or operation of goods and services within a business. It is
specifically designed for internal use by the managers and decision-makers of a company.
Here is how a cost sheet looks like:

Here are a few important terms to comprehend a cost sheet better:
● Prime cost: It represents all the direct costs incurred by a company.

○ Prime cost = Direct materials cost + Direct labour + Direct expenses
● Manufacturing cost/product cost: It is the summation of prime cost, manufacturing
overheads (indirect manufacturing costs), and change in work-in-progress cost.
○ Manufacturing/Production cost = Prime cost + Manufacturing overheads +
Opening work-in-progress cost
● Cost of goods available for sale: As the name is self-explanatory, it is the total product
cost with the opening stocks of finished products.
○ Cost of goods available for sale (COGAS) = Manufacturing cost + Opening stock
of finished goods
● Cost of goods sold: It represents the cost of the total goods sold.
○ Cost of goods sold (COGS) = Cost of goods available for sale − Closing stock of
finished goods
● Gross profit: It is the difference between the net sales and the cost of goods sold.

○ Gross profit = Net sales − Cost of goods sold
Revenue Analysis
Revenue is defined by the total amount of money a business generates from its primary
activities, which typically involve selling goods or services to customers. It does not include any
deduction and represents the money a company receives through its sales in a specific period
of time. There are three concepts of revenue. They are as follows:
● Total Revenue (TR): It represents the total amount the firm generates by selling the total
quantity of the goods produced. It can be calculated as ‘TR= P×Q’, where ‘TR’ is Total revenue,
‘P’ is the price of a single product and ‘Q’ is the quantity sold in the period.
●
● Average Revenue (AR): It represents the revenue earned per unit of the products sold.
Note that the AR is the same as the price of the product in most cases. AR can be
calculated as ‘AR = TR/Q = P×Q/Q = P’.
● Marginal Revenue (MR): It represents the additional revenue a company generates by

producing an extra unit. It can be calculated as ‘MR nth = TR(n) − TR(n−1)’, where ‘n’
stands for the number of goods produced.
Break-Even Analysis
The break-even point refers to a state in business where the Total Cost (TC) equals the TR. It
is represented by ‘TC = TR’.

While calculating the break-even point, the following things are considered:
● TR = TC
● TC = Fixed costs + Average variable cost × Quantity
● Price × Quantity = Fixed cost + Average variable cost × Quantity
● Fixed cost = Price × Quantity − Average variable cost × Quantity
● Fixed cost = Quantity × (Price−Average variable cost)
Applying these, we get ‘Break-even quantity = Fixed cost (Price per good−Average variable
cost)’.
Hence, the quantity required to reach the break-even point is obtained by dividing the fixed cost
by the difference between the product’s price and the average variable cost.

Application of Break-Even Analysis
The break-even point can be used in the following cases in a business scenario:
● Calculation of sales volume and price to attain target profit
Required sales volume = (Fixed costs+Target profit) / (Selling price per unit−Variable cost per
unit)
● Safety margin
Safety margin ratio = (Actual sales−Break even sales) / Actual sales
● Sales required to offset price reduction
New quantity of sales = (Fixed costs+Profit target) / (New sales price−Variable costs)
● Sales required to meet proposed expenditure
Additional sales = Proposed expenditure / Contribution margin per unit = Proposed expenditure
/ (Price per unit−Variable cost per unit)
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Cost Analysis

Cost is divided into the following categories:

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Total cost = Fixed costs + Variable costs

© upGrad Campus Private Limited. All rights reserved.

● Prime cost: It represents all the direct costs incurred by a company.

© upGrad Campus Private Limited. All rights reserved.

● Marginal Revenue (MR): It represents the additional revenue a company generates by

© upGrad Campus Private Limited. All rights reserved.

Safety margin ratio = (Actual sales−Break even sales) / Actual sales

● Sales required to offset price reduction

● Sales required to meet proposed expenditure

© upGrad Campus Private Limited. All rights reserved.

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