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. 237238
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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 Spring '09
 LYZ
 Financial Accounting, higher proportion, CM Op Inc

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