To explain an inflation effect on stated costs, apply each stated increase to the cost it belongs to, add up the new total, then compare it with revenue. Use only the increases the case gives you.
This skill supports external business conditions and relies on the same profit arithmetic as costs, revenue and break-even.
What is the idea behind it?
Inflation means prices in general are rising, so a firm pays more for the same inputs. The effect on one firm depends on its mix of costs. A firm that spends mostly on ingredients feels a food-price rise strongly, and a firm with a fixed rent feels it less.
That is why you work cost by cost instead of applying one percentage to the total.
How do you work through it?
- List each cost and its current monthly amount.
- Find which costs change and by how much, using only the case.
- Calculate each new amount, then the new total.
- Find the change in total cost, in ringgit and as a percentage of the old total.
- Compare with revenue to see the effect on profit, and state what you assumed.
Worked example
Dapur Selera Sdn Bhd is a catering firm in Ipoh. Monthly revenue is RM42,000. The case states these monthly costs and increases next year.
| Cost | Now (RM) | Stated change | New (RM) |
|---|---|---|---|
| Ingredients | 18,000 | +6% | 19,080 |
| Wages | 12,000 | +4% | 12,480 |
| Rent | 5,000 | fixed by contract | 5,000 |
| Electricity | 2,000 | +10% | 2,200 |
| Total | 37,000 | 38,760 |
Workings: 18,000 × 1.06 = 19,080. 12,000 × 1.04 = 12,480. 2,000 × 1.10 = 2,200.
The total is 19,080 + 12,480 + 5,000 + 2,200 = 38,760.
Total cost rises by 38,760 − 37,000 = RM1,760, which is 1,760 ÷ 37,000 = 4.76%.
Profit was 42,000 − 37,000 = RM5,000. It is now 42,000 − 38,760 = RM3,240, a fall of 1,760 ÷ 5,000 = 35.2%.
To keep RM5,000 profit with the same number of customers, revenue must rise by RM1,760, which is 1,760 ÷ 42,000 = 4.19%. The case does not say whether customers would accept this, so the answer should say that evidence is needed.
The cash versus profit bridge is a useful companion, because higher costs reduce profit at one moment and cash at another.
The mistake to watch for
Mistaken answer: “Inflation is 5%, so costs rise by 5% of RM37,000, which is RM1,850.”
The student applied one rate to every cost, including the rent that is fixed by contract. The case gave separate increases, and the real rise is RM1,760.
Correction: use the stated increase for each cost, and leave unchanged any cost the case says is fixed. A general rate is only a fallback when nothing more specific is given, and then you should say so.
Check yourself
1. A firm’s materials cost RM8,000 a month and rise by 3%. What is the new monthly cost?
Show answer
8,000 × 1.03 = RM8,240. The increase is RM240.
2. A shop has revenue of RM25,000 and costs of RM20,000. The costs all rise by 5%. Revenue stays the same. Find the new profit.
Show answer
New costs: 20,000 × 1.05 = RM21,000. New profit: 25,000 − 21,000 = RM4,000, down from RM5,000.
3. A firm spends RM30,000 on materials, which rise by 8%, and RM10,000 on wages, which do not change. By what percentage do its total costs rise?
Show answer
Materials rise by 30,000 × 0.08 = RM2,400. Total before: RM40,000. The rise is 2,400 ÷ 40,000 = 6%, lower than 8% because wages are unchanged.
Where this leads next
Go back to tracing an exchange rate change if foreign currency costs are involved, or move on to comparing trade exposure for two firms. The external business conditions practice set mixes all five skills.
If you lose marks by applying one rate to every cost, a teacher can drill the cost-by-cost method with you in online one-to-one Business tuition.