Lesson preview · Costs, revenue and profit
Revenue, profit and breaking even
~7 min · Free to read
Mina runs a small café. Last month she sold 3,000 cups of coffee at 5 dollars each, so 15,000 dollars came in. A friend says she must be rich.
You can’t tell yet. That 15,000 dollars is what the café took, not what Mina kept. First she has to pay the rent and buy the coffee and milk.
Key Term
Revenue and profit
Total revenue is all the money a business takes from its sales: the price of each item times the number sold. Mina’s total revenue was 5 × 3,000 = 15,000 dollars. Average revenue, the revenue per item sold, is total revenue ÷ the number sold. Mina’s is 15,000 ÷ 3,000 = 5 dollars, the same as her price.
Profit is what’s left of the revenue once the business has paid its costs. If the costs are bigger than the revenue, profit is negative, and the business makes a loss.
Total cost is fixed costs plus variable costs.
Mina’s costs come in two kinds. Fixed costs stay the same however many cups she sells. Her rent, insurance and the loan on her coffee machine come to 6,000 dollars a month. Variable costs rise with every cup: each one uses 2 dollars of coffee, milk and a paper cup.
That 2 dollars is the same for every cup, so it is also her average variable cost: the variable cost per cup.
Key Term
Breaking even
A business breaks even when its total revenue exactly equals its total cost, so its profit is zero. The number of units it must sell to get there is its break-even point. Below it, the business makes a loss. Above it, it makes a profit.
Each of Mina’s 5-dollar cups first pays for its own 2 dollars of coffee, milk and cup. What’s left over goes towards her 6,000 dollars of fixed costs. Once the leftovers reach 6,000 dollars, she breaks even.
The bottom of the fraction is what each unit sold leaves over to pay the fixed costs. The formula assumes every unit has the same variable cost.
Break-even splits Mina’s month in two. The 3 dollars left by each of her first 2,000 cups pays off her fixed costs. The 3 dollars from each cup after that is profit, so of her 15,000 dollars of revenue, she kept 3,000.
Trap · Common Misconception
"Big revenue means big profit"
In 2019, the ride-hailing company Uber took in about 14.1 billion US dollars of revenue. Its costs were even bigger, so it made a loss of about 8.5 billion US dollars that year. Revenue measures what a business sells, not what it keeps.
Key Term
Keep going while the extra unit pays
Should Mina open on Sundays too? A Sunday would bring in 400 dollars of extra revenue. It would add 300 dollars of extra cost: coffee, milk and a day’s pay for a barista. Her rent stays the same, so it doesn’t count. Profit rises by 100 dollars, so she opens.
The rule: keep producing while the extra unit adds more to revenue than to cost. Economists call these extras marginal revenue and marginal cost: what one more unit (here, a Sunday) adds to revenue and to cost.
Trap · Common Misconception
"More sales always means more profit"
Opening on Sunday evenings too would bring in 150 dollars but add 200 dollars of staff pay, heating and coffee. Revenue rises by 150 dollars, but profit falls by 50 dollars. A business that wants the most profit looks for the biggest gap between revenue and cost, not the biggest revenue.
Is 3,000 dollars a month a good profit? That depends on what Mina gave up. Before the café, she earned 2,500 dollars a month managing a shop. That lost pay is her opportunity cost: the value of the next best thing she could have done instead.
Key Term
Normal and economic profit
Mina’s 3,000 dollars is her accounting profit: revenue minus the costs the business pays.
Normal profit is the profit an owner needs just to stay in the business: enough to match their next best option. For Mina, that’s 2,500 dollars a month.
Economic profit is accounting profit minus normal profit. Mina’s is 3,000 − 2,500 = 500 dollars a month. A positive economic profit is also called supernormal profit, and a negative one is an economic loss.
If her profit were exactly 2,500 dollars, her economic profit would be zero. That isn’t failure: she’d be doing just as well as in her old job.
Check yourself · no marks
In a quiet month, Mina sells only 2,400 cups. Is she above her break-even point? Is she earning normal profit?
Commit to one first. Guessing and being wrong beats reading the answer cold.
Practice · 1 / 6
A school club sells 80 T-shirts at 12 dollars each. The club paid 7 dollars for each shirt. What is the club’s total revenue from the shirts?
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