Basic financial terms and calculations
AQA also says:
Spec content: Basic financial terms; Basic financial calculations.
Students should be able to: understand the difference between variable costs, fixed costs and total costs; understand the concept of revenue, costs, profit and loss.
Essential Financial Terms
Every business needs to understand its finances. Before analysing performance or making investment decisions, a clear grasp of the fundamental financial terms is essential. These concepts underpin everything from day-to-day management to formal financial reporting.
Costs
A business incurs costs in order to produce its goods or services. Costs fall into two categories:
- Fixed costs — costs that do not change with the level of output. They must be paid regardless of whether the business produces one unit or one thousand. Examples: rent, insurance, management salaries, loan repayments. Fixed costs create a financial obligation even when revenue is low.
- Variable costs — costs that change directly with the level of output. The more a business produces, the higher its variable costs. Examples: raw materials, packaging, direct labour paid per unit produced, electricity used in production.
Total costs (TC) = Total fixed costs (TFC) + Total variable costs (TVC)
Worked example: A bakery has fixed costs of £2,000 per month (rent, insurance) and variable costs of £0.50 per loaf. If it produces 3,000 loaves in a month:
TVC = 3,000 × £0.50 = £1,500
TC = £2,000 + £1,500 = £3,500
Revenue
Revenue (also called turnover or sales revenue) is the total income a business receives from selling its goods or services before any costs are deducted.
Revenue = Price × Quantity sold
Worked example: The bakery sells its loaves at £2.00 each and sells 3,000 loaves:
Revenue = £2.00 × 3,000 = £6,000
Profit and Loss
Profit is what remains when total costs are subtracted from revenue. It is the reward for the risk taken by the business owner.
Profit = Revenue − Total costs
If costs exceed revenue, the business makes a loss.
Worked example (continuing):
Revenue = £6,000
Total costs = £3,500
Profit = £6,000 − £3,500 = £2,500
Profit can be reinvested into the business (retained profit), paid to owners as a dividend, or used to repay debts. A business that consistently makes a loss will eventually run out of cash and fail.
Key Takeaways
- Fixed costs do not change with output (rent, insurance); variable costs rise and fall with output (raw materials, packaging).
- Total costs = Total fixed costs + Total variable costs
- Revenue = Price × Quantity sold
- Profit = Revenue − Total costs. If costs exceed revenue, the result is a loss.
- Revenue is not the same as profit — a business can have high revenue and still make a loss if its costs are higher.