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CIE IGCSE Business Your notes
4.2 Costs, Break-even & Production Scale

Contents
Different Types of Costs
Economies of Scale
Diseconomies of Scale
Break-even Charts
Break-even Calculations
The Limitations of Break-even Analysis
Page 1 of 29
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Different Types of Costs

Your notes
Different Types of Business Costs
Businesses incur a range of costs
Examples include purchasing raw materials, paying staff salaries/wages and paying utility
bills such as electricity
These costs can be classified as follows
Fixed costs
Variable costs
Total costs
Average costs
An Explanation of the Different Costs of a Business
Type of Cost Diagram Explanation
Fixed Cost (FC) Fixed costs (FC) are costs that do not
change as the level of output changes
These have to be paid whether the
output is zero or 5000
E.g. Building rent, management
salaries, insurance, bank loan
repayments etc.
The fixed costs for this firm are $4,000
Variable Cost Variable costs (VC) are costs that

(VC) change directly with the output
These increase as output increases
and vice versa
E.g. Raw material costs, wages of
workers directly involved in the
production
Total Cost (TC) The total cost is the sum of the variable &
fixed costs
The total costs cannot be 0 as all firms
have some level of fixed costs
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Your notes
Average Total As a firm grows, it is able to increases its

Cost (AC) scale of output generating efficiencies
that lower its average total costs (AC) of
production
These efficiencies are called economies
of scale
As a firm continues increasing its scale of
output, it will reach a point where its
average total costs (AC) will start to
increase
The reasons for the increase in the
average costs are called diseconomies
of scale
Cost Calculations
Based on the above definitions, we can calculate several different types of costs
1. Total costs (TC) = total fixed costs (TFC) + total variable costs (TVC)
2. Total variable cost (TVC) = variable cost (VC) × quantity (Q)
Cost Calculations Using the Above Formulas Where VC is £60
Output (Q) FC TVC = $ 60 x Q TC = TFC + TVC
0 200 - 200
1 200 60 260
2 200 120 320
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3 200 180 380

Your notes
Worked example
Aromas Cannelles manufactures luxury scented candles. The production of each candle incurs the
following costs
Item € per Candle
Wax 0.14
Perfume oil 0.72
Loan repayment 100
Glass jar 1.46
Outer Packaging 0.33
Calculate the variable cost in € for each candle. (2)

Step 1 - Identify the variable costs in the list
Loan repayment is classified as a fixed cost so should not be included in the calculation
Step 2 - Total the variable costs listed

0.14 + 0.72 + 1.46 + 0.33 = 2.65 (1 mark)
Step 3 - Express the answer in € per Candle

= €2.65 (2 marks for the correct answer)
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Exam Tip
Your notes
Take care when calculating variable costs per unit as it is likely that one or more fixed costs will be
included in the list as seen above.
If you are asked to calculate the total variable costs, follow the above process and multiply the answer
by the number of units produced/sold.
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Using cost data to make Decisions

Businesses can use cost data to make data-driven business decisions Your notes
Diagram of what Decisions cost data Influences
Accurate cost data can help a firm to be more precise in its price setting and production decisions
Explaining the Diagram
Reducing costs
Accurate cost data can help a business identify of their costs are too high
An important way to improve profit is to reduce costs
Fixed costs may be reduced by relocating to cheaper business premises, reducing salaries for
workers, spending less on promotional activities or seeking lower-priced utility providers
Variable costs may be reduced by sourcing cheaper materials, buying raw materials in bulk, or
outsourcing distribution to a third party business
E.g. Many businesses sell their products using Amazon which manages the packaging and
shipping of items, usually at a cost much lower than the business itself could achieve
Businesses must carefully consider the impacts of reducing costs on customer service, quality and
speed of delivery
Paying lower salaries to staff may mean that employees have fewer customer service skills or
experience
Cheaper raw materials and components may lead to worsening quality
Setting prices
Costs play an important role in the determination of selling prices
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They are a crucial part of making, or increasing profit

E.g. If the average cost of making a cake = $3 and the business wants to make $1 profit on each
cake sold, it will need to charge a price of $4 Your notes
Production decisions
If the cost of producing a product is higher than the revenue it generates the business will make a loss
It will need to decide whether to continue making the product or stop
This decision depends on various factors including
Whether the product has just been launched on the market, in which case the sales revenue may
increase in future
Whether the fixed costs will still have to be paid
Location decisions
Property rental or the purchase of premises can be a substantial monthly cost
Some locations are cheaper than others
A business must weigh up the cost of the location against other important factors such as
transport links, proximity to customers and availability of a workforce
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Economies of Scale
Your notes
Economies of Scale
As a business grows, it is able to increases its scale of output which generates efficiencies that lower
its average costs (AC) of production
These efficiencies are called economies of scale
Economies of scale help large firms lower their costs of production beyond what small firms are
able to achieve
Economies of scale can result in lower average (or unit) costs, not lower total costs
The total costs will increase, but at a decreasing rate per unit
Diagram Explaining Economies of Scale
Economies of scale lower average costs as the scale of output increases

Diagram analysis
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With relatively low levels of output, the firms average costs are high
As the firm increases its output, it begins to benefit from economies of scale which lower the average
cost per unit Your notes
The business will reach a level of output at which costs are minimised
Beyond this point, diseconomies of scale will occur and the average cost will start to rise again
Different types of economies of scale
Economies of scale are generated by several internal factors, some of which the business has control
over
Businesses will attempt to benefit from as many of these economies as possible in order to lower their
costs and increase their profit
Explanation of the Different Economies of Scale
Type of Economy of Scale Explanation
Purchasing Economy Occurs when large firms buy raw materials in greater volumes and
receive a bulk purchase discount, which lowers the average cost
This provides a cost advantage over smaller businesses
Managerial Economy Occurs when large firms can employ specialist managers who are
more efficient at certain tasks, and this efficiency lowers the average
cost. Managers in small firms often have to fulfil multiple roles and are
less specialised
They may attract the best talent from other businesses
increasing competitive advantage
Marketing Economy Occurs when large firms spread the cost of advertising over a large
number of sales and this reduces the average costs
They can also reuse marketing materials in different geographic
regions which further lowers the average costs
Financial Economy Banks are more willing to lend to large businesses as they present
less of a risk than small businesses
They will be charged a lower rate of interest on their borrowings,
reducing average costs
Technical Economy Occurs as a firm is able to use its machinery at a higher level of
capacity due to the increased output
This spreads the cost of the machinery over more units and
lowers the average cost
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Exam Tip
Your notes
When explaining economies of scale, make sure that you fully explain how each type lowers the
average costs for the business. This is different to only saying that is lowers the average cost. E.g. Bulk
purchases result in the business benefitting from cheaper raw materials, which lowers the cost per unit
Page 10 of 29
Your notes
As a firm continues increasing its scale of output, it will reach a point where its average costs (AC) will
start to increase
The reasons for the increase in the average costs are called diseconomies of scale
Diagram to show Diseconomies of Scale
Diseconomies of scale occur when average costs increase with increasing output
Diagram analysis
At some level of output, a firm will not be able to reduce costs any further. This point is called
productive efficiency
Beyond this level of output, the average cost will begin to rise as a result of diseconomies of scale
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This indicates that there is an optimal level of output that exists when the state of technology and
capital (machinery) is fixed
Different types of diseconomies of scale Your notes
Diseconomies of scale highlight that it is possible for a business to become so large that it becomes
less and less efficient
A business experiencing diseconomies of scale may reconsider its organisational structure to
improve communication and coordination problems
Many very large businesses often break themselves up into autonomous smaller units, which can
communicate more effectively
Explanation of Diseconomies of Scale
Type of Diseconomy of Scale Explanation
Poor communication As a business increases in size, more managers and employees will join
the business
Communication becomes slower and mistakes may be made, leading
to worsening efficiency
Poor coordination Time-consuming decision-making may make it harder to coordinate

workers and physical resources
The chain of command is likely to lengthen, limiting interaction with

employees
Lack of commitment from As the business grows workers may feel less valued as their interaction
employees with management is limited
Workers may become demotivated leading to a fall in output which can

increase average costs
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Break-even Charts
Your notes
An Introduction to Break-even
Break-even analysis is a financial tool used to determine the number of units a business must sell to
reach the point where the business revenue equals its expenses (no profit nor loss)
It helps businesses understand the minimum level of sales or output they need to achieve in
order to cover all costs
This helps business managers to make informed decisions about pricing and production volumes
The break-even point is the number of units that need to be sold for total costs to equal the sales
revenue
Diagram with the Elements of a Break-even Analysis
Variable costs, fixed costs and sales revenue are all used in calculating the break-even point
Fixed costs are costs that do not change regardless of the level of production or sales
E.g. rent, salaries and insurance
Variable costs are costs that vary with the level of production or sales
E.g. raw materials, direct labour costs, packaging and shipping costs
Sales revenue is the money gained from selling products/service and is calculated as follows
Sales revenue = number of items sold x selling price
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Constructing a Break-even Chart

Break-even charts are graphs which show how costs and revenues of a business change with sales Your notes
It identifies the number of units a business must sell in order to break-even
In order to construct a break-even chart the business needs to know the estimated fixed costs,
variable costs and sales revenue
Break-even Table of Costs and Revenue for Tee-Crazy Ltd
Sales $ = 3000
Sales $ = 0 units Sales $ = 500 units
units
Fixed Costs 8,800 8,800 8,800
Variable Costs 0 2,000 12,000
Total Costs 8,800 10,800 20,800
Total Revenue 0 5,000 30,000
Tee Crazy Ltd has the following estimates

Fixed costs are $8,800 per year
The variable costs of each t-shirt is $4
Each t-shirt is sold for a price of $10
The factory can produce a maximum output of 3000 t-shirts per year
Diagram of how to Construct a Break-even Chart
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Your notes
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Your notes
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Your notes
Five steps to constructing the perfect break-even chart
Production output below the break-even point results in the business making a loss
Production output above the break-even point results in a profit
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Interpreting a Break-even Chart

A break even chart is a visual representation of the break-even point and is used to identify several key Your notes
metrics
The break-even point
The margin of safety
The expected profit or loss
Diagram of a Break-even Chart
The break-even chart for A2B Limited shows that at 324 units the total revenue = the total costs
Diagram analysis
Fixed costs do not change as output increases
A2B's fixed costs are £8,000 and these do not change whether the business produces 0 units or
500 units
Total costs are made up of fixed and variable costs

At 0 units of output, they are made up exclusively of fixed costs
At 500 units the total variable costs equate to £11,800
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This line slopes upwards because total variable costs increase as output increases
The revenue line also slopes upwards Your notes

At 0 units of output, the revenue is £0
At 500 units the total revenue equates to £11,800
Revenue will increase with the output
The line will slope more steeply than the total costs and will cross the total costs line at some
point
The point at which the total costs and the revenue lines cross is the break even point
The break even level of output for A2B is 324 units
The margin of safety can be identified as the difference on the x-axis between the actual level of
output (in this case 450 units) and the break even point (300 units). The margin of safety is 150 units
The profit made at a specific level of output can be identified as the space between the revenue and
total costs lines
In this instance, the profit made at 450 units of output is £14,400 - £11,250 = £3,150
Exam Tip
When calculating the break-even point write down the break-even formula first and then find the
figures you need to fill in the data required.
This allows you to check that you have everything you need for the calculation. You will be able to
identify very quickly whether you need to carry out further calculations such as total fixed costs.
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Break-even Calculations
Your notes
Calculating Break-even
The break-even point can be calculated using one of two formulas
The first calculates the number of units which need to be sold to break-even
Fixed cost
Breakeven point in units =
( Selling price − variable cost )
The second calculates the value of the costs/revenue at which point the firm breaks even
Break − even point value = break − even point in units × selling price
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Worked example
Your notes
Mięsisty Burgers has the following financial information for the month of May.
€ May
Raw materials for each burger 2.10
Packaging for each burger 0.20
Fixed costs 1 730
Selling price of each burger 4.95
(a) Using the information in the table, calculate the level of output required to break even in May. You
are advised to show your workings (3 marks)
Step 1 - Calculate the variable costs per burger
Variable cost per burger = Raw materials + Packaging
Variable cost per burger = € 2. 10 + € 0. 20 (1 mark)
= € 2. 30
Step 2 - Substitute the values into the breakeven formula
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Fixed Cost
Break even point in units =
(Selling price − variable cost ) Your notes
1, 730
(4. 95 − 2. 30)
1, 730 (2 marks)
(2. 65)
1, 730
(2. 65)
Break even point in units = 653
Step 3 - Round to the nearest unit

653 burgers need to be sold to break even in May (2 marks for a correct answer)
Exam Tip
Always round up the break even point to the nearest whole unit
Page 22 of 29
The Margin of Safety

The margin of safety is the amount by which the number of units sold is greater than the break even Your notes
point
The margin of safety provides useful information to a firm on how many sales they could lose before
they start making a loss
The margin of safety can be calculated using the following formula
Margin of safety = quantity of sales − breakeven level of sales
Businesses want their margin of safety to be as large as possible

This means that if demand for their products drops unexpectedly, the business will continue to
make a profit
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Worked example
Your notes
Figure 1 shows the weekly break-even diagram for the Yorkshire Rare Breed Sausage Company.
Figure 1: Output, Costs & Revenues of the Yorkshire Rare Breed Sausage Company
Using Figure 1 above, calculate the weekly margin of safety. Show your workings and the formula used.
(3)
Step 1 - Write the formula down
Margin of safety = quantity of sales − breakeven level of sales (1 mark)
Step 2 - Read from the chart and substitute values into the formula
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Margin of safety = quantity of sales − breakeven level of sales

Margin of safety = 4,000 − 2,500
Your notes
Margin of safety = 1,500 sausages
(1 mark for any correct working; 3 marks for the correct answer)
Exam Tip
Use a ruler to help you to read break even charts accurately.
Page 25 of 29
Using Break-even Analysis to make Decisions

Break-even calculations are a useful tool for a business to use in deciding how much to produce and Your notes
calculating estimated levels of profit
It is particularly useful for communicating with stakeholders including investors or lenders

Knowing when the business will break-even or how much profit it is expected to make may attract
or deter shareholders from investing in the business
Break-even analysis provides a basis for informed decision making

It helps the business to assess the costs and expected returns of new projects and expansion
plans
By considering the break-even point, businesses can assess the potential risks and rewards
associated with different decisions
Examples of Using Break-even in Decision-making
Use of Break-even Explanation
Assessing profit or loss It allows businesses to assess their profitability by determining the
minimum level of sales needed to cover all costs
It helps identify the level of sales required to avoid losses and provides a
target for achieving profits
Managing costs Break-even analysis helps in identifying fixed and variable costs and their
impact on the business
By understanding the cost structure businesses can evaluate their

spending patterns and reduce unnecessary expenses
Pricing decisions Break-even analysis provides insights into pricing decisions by helping
businesses determine the minimum price required to cover costs and
achieve the desired level of profit
It ensures that prices are set at a level that generates sufficient revenue to
meet expenses and generate profits
Financial planning
Page 26 of 29
Break-even analysis assists in financial planning by providing a reference

point for target setting such as realistic sales targets and plans for
necessary expenses Your notes
Redrawing the graph with Break-even analysis allows businesses to see the impact of changes in
changes variables such as costs, prices, and sales volumes on the break-even
point
This helps in understanding the potential risks and uncertainties such as a

new competitor entering the market or suppliers increasing prices
Performance monitoring Break-even analysis serves as a benchmark for monitoring business

performance over time
By comparing actual sales and costs against the break-even point

businesses can assess their financial health and track progress
Page 27 of 29
The Limitations of Break-even Analysis

Your notes
The Limitations of Break-Even Analysis
Break-even analysis provides valuable insights into the financial viability and performance of a
business
The sooner a business can reach break-even point, the more likely it is to survive and make a profit
There are several limitations to the use of break-even analysis
Diagram Explaining the Limitations of Break-even Analysis
Break-even analysis is only useful if the data it is based on is accurate
The limitations of break even analysis can be used to evaluate the usefulness of this tool for a start up
or growing business
The most significant limitation of break-even analysis, is that it is entirely dependent on the accuracy of
the data used to construct it
This data may be difficult to accurately calculate
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The data may be subject to frequent fluctuations, which can significantly impact the break-even
level of output
The data may require specialist knowledge/skills to gather, meaning that it is perhaps easier to be Your notes
accurate in larger organisations than smaller ones
Exam Tip
When evaluating break-even analysis, ensure that you explain why it has an important internal planning
role - but don’t forget that it has a significant external role too. Break even analysis should be included
in a business plan when a business is trying to secure external finance. Businesses looking to borrow
money or attract investors seeking to manage their risk should take care to model the break even
point, margin of safety and level of profit (or loss) at different levels of output and be prepared to be
scrutinised on the figures.
Page 29 of 29

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CIE IGCSE Business Your notes

4.2 Costs, Break-even & Production Scale

Different Types of Costs

An Explanation of the Different Costs of a Business

Type of Cost Diagram Explanation

Variable Cost Variable costs (VC) are costs that

Average Total As a firm grows, it is able to increases its

Cost Calculations Using the Above Formulas Where VC is £60

Output (Q) FC TVC = $ 60 x Q TC = TFC + TVC

2 200 120 320

3 200 180 380

Item € per Candle

Perfume oil 0.72

Loan repayment 100

Glass jar 1.46

Outer Packaging 0.33

Calculate the variable cost in € for each candle. (2)

Step 2 - Total the variable costs listed

Step 3 - Express the answer in € per Candle

Using cost data to make Decisions

They are a crucial part of making, or increasing profit

Economies of scale lower average costs as the scale of output increases

Type of Economy of Scale Explanation

Explanation of Diseconomies of Scale

Type of Diseconomy of Scale Explanation

Poor coordination Time-consuming decision-making may make it harder to coordinate

The chain of command is likely to lengthen, limiting interaction with

Workers may become demotivated leading to a fall in output which can

Constructing a Break-even Chart

Variable Costs 0 2,000 12,000

Total Costs 8,800 10,800 20,800

Total Revenue 0 5,000 30,000

Tee Crazy Ltd has the following estimates

Five steps to constructing the perfect break-even chart

Interpreting a Break-even Chart

Total costs are made up of fixed and variable costs

The revenue line also slopes upwards Your notes

Step 1 - Calculate the variable costs per burger

Variable cost per burger = Raw materials + Packaging

Variable cost per burger = € 2. 10 + € 0. 20 (1 mark)

Step 2 - Substitute the values into the breakeven formula

Break even point in units = 653

Step 3 - Round to the nearest unit

The Margin of Safety

Businesses want their margin of safety to be as large as possible

Step 1 - Write the formula down

Margin of safety = quantity of sales − breakeven level of sales (1 mark)

Margin of safety = quantity of sales − breakeven level of sales

Using Break-even Analysis to make Decisions

It is particularly useful for communicating with stakeholders including investors or lenders

Break-even analysis provides a basis for informed decision making

Examples of Using Break-even in Decision-making

Use of Break-even Explanation

By understanding the cost structure businesses can evaluate their

Break-even analysis assists in financial planning by providing a reference

This helps in understanding the potential risks and uncertainties such as a

Performance monitoring Break-even analysis serves as a benchmark for monitoring business

By comparing actual sales and costs against the break-even point

The Limitations of Break-even Analysis

Break-even analysis is only useful if the data it is based on is accurate

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