Revenue, costs, profit and loss: the definition and calculation of revenue, fixed, variable and total costs, the calculation of profit or loss, the importance of profit, and the difference between cash and profit.

What this topic is asking

OCR J204 topic 5.3 wants you to define and calculate revenue, to classify costs as fixed, variable or total, to calculate profit or loss, to explain why profit matters, and to distinguish cash from profit. These are the building blocks for break-even and cash flow, so the formulae here are used again and again on Paper 2. Almost every Section B question on Finance starts by testing whether you can get revenue, costs and profit right.

Revenue

Revenue is the top line of the business: it is not profit, because nothing has been deducted yet. A business can raise revenue by selling more units or by charging a higher price, but raising the price may cut the quantity sold, so the two have to be balanced.

Costs

Costs are everything the business spends to make and sell its product. OCR splits them into fixed and variable, which then add up to total cost.

The split matters because fixed costs are spread more thinly as output rises (lowering the cost per unit), while variable costs stay the same per unit however much is made.

Profit and loss

A loss is not automatically fatal: a new business often makes a loss while it builds up sales, and it can survive as long as it has the cash to keep going. But a business that makes losses for too long will run out of money and fail.

Why profit matters

Most businesses treat profit as a core objective, though not the only one: survival, growth, customer satisfaction and ethical aims matter too, especially for a start-up or a social enterprise.

Cash is not profit

This distinction recurs throughout Finance. Profit is revenue minus costs measured over a period. Cash is the money actually available at a point in time. A business can be profitable on paper yet short of cash, because its money is tied up in unsold stock or in invoices customers have not yet paid. That is why a profitable business can still fail if it cannot pay its bills on time, and why cash and profit are managed as separate things.

Try this

Q1. A business sells $500$ units at $20$ each. Calculate its revenue. [1 mark]

• Cue. $20 \times 500 = 10{,}000$.

Q2. Fixed costs are $8{,}000$, variable cost is $4$ per unit, and output is $3{,}000$ units. Calculate the total cost. [2 marks]

• Cue. Variable: $4 \times 3{,}000 = 12{,}000$; total: $8{,}000 + 12{,}000 = 20{,}000$.