2.3 She recognises that the van will gradually move from a value of £1,200 to nil over the 12 months that she is trading. She therefore needs to spread the cost over that period, and she does this by reducing its value by £100 a month. This reduction, reflecting the effective consumption of the fixed asset by its use, is called depreciation. 2.4 She therefore incurs a rental charge of £500 per month and depreciation of £100 per month. The net profit or loss is therefore the gross profit on the sales in the month, less the overhead costs in respect of the rent and depreciation. “Overhead costs” are those costs which are costs of the business but which are not the direct costs of those items which have been sold. Overhead costs might be described alternatively as “fixed costs” (on the basis that they are broadly constant, regardless of activity levels), or administrative expenses (borrowing some terminology from the Companies Acts). 2.5 As Jane has fixed costs of £600 per month, and she makes a gross profit on each windsurfer sold of £300, we can compute her break-even point: the break-even point is the fixed costs as divided by the gross profit percentage: we therefore divide £600 by 0.3, and this gives the level of break-even sales. This is £2,000. Therefore Jane needs to sell an average of 2 windsurfers every month in order to cover her rental cost and depreciation and to have nothing left.
2.6 We can follow her venture through the monthly accounts that she produces:
Month
January
February
March
Number sold
- -
2
3
Sales
2,000 _____
3,000 _____
_____
Purchases
7,000
-
3,500 5,600
Opening stock
-
7,000
Less: Closing stock
(7,000) _____
(5,600) _____ 1,400 _____
(7,000)
______
Cost of sales
-
2,100 _____
_____
Gross profit
-
600
900
_____
_____
_____
Overheads: rent
500 100 600 ___
500 100 600 ___ - ===
500 100 600
Overheads: depreciation
Total overheads
____
Net profit/(loss)
(600) ===
300 ===
Gross profit %
30%
30%
Net profit %
0%
10%
3
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