Suppl note op leverage etc. - Intro Cost Suppl Note re Cost...

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Intro Cost – Suppl. Note re Cost Structure, Op Leverage, and Indifference Points Cost Structure and Profit Stability Which cost structure is more stable or more profitable? A higher proportion of variable costs or a higher proportion of fixed costs? Refer to example on p. 237-238 A higher proportion of fixed costs implies a lower proportion of variable costs and hence higher CM and CM ratio. When sales are good, profits will increase faster with a higher CM ratio and higher fixed costs relative to variable costs. However, in a downturn, variable costs can be shut off whereas fixed costs cannot. Therefore a higher proportion of fixed costs will lead to higher financial risk. As a result, if sales volumes are widely variable from year to year, a lower CM ratio and a higher proportion of variable costs would lead to lower losses in bad years. Hence, there is a trade off here between profitability and risk and each business has to look at its own future sales prospects to determine which cost structure is best. Operating Leverage
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Suppl note op leverage etc. - Intro Cost Suppl Note re Cost...

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