Operating Leverage

OPERATING LEVERAGE

In any business venture , whether the goal is to have as many profits as possible or just be at break-even , there would always be costs that the business has to endure . And these costs are classified into two : fixed costs and variable costs . The latter is the cost that varies as the output of the business changes ADDIN EN .CITE 1143Variab le CostMay 12 2007www .cfdccariboo com /glossary .htm "Variable Cost . On the other hand , fixed costs are the costs to a business that is not affected by

the level of output ADDIN EN .CITE 2243Fixed CostMay 12 2007www .econ100 .com eu5e /open /glossary .html "Fixed Cost . With this , every business venture , regardless of type , wants to minimize their costs for it would make them more efficient . In economics , to know whether the business is in good shape or not , the ratio between the fixed cost vis-a-vis the obtained . This ratio is called the operating leverage ADDIN EN .CITE Operat ing Leverage2007May 12 2007http /www .inves torwords .com /3462 /operating_leverage .html "Operating Leverage " 2007 . With this knowledge about costs , specifically fixed costs and the operating leverage , how do managers exactly apply this in real company data particularly in its profits

For starters , profit is defined as revenues minus the costs . There are three ways to maximize profits : to increase revenues , to decrease costs or a combination of the two . Concentrating on the second option , if a company has a significant amount of operating leverage , then it is quite safe to say that the business is in trouble . This is because if its fixed cost is high , even if it chooses not to produce anything , it would still have to pay certain costs . Therefore , even if volumes of sales increase , this would only translate to small profits . With this managers try to alter the operating leverage to be able to increase the business 's profitability

Usually , managers look for certain methods on how to attain the lowest possible operating leverage for the company . Once this is obtained , then even if only a fraction of increase in the volume of sales materializes the company brings in huge profits . Why ? This is because only a few percentages are translated into fixed costs hence the company could fully maximize the utility of the profits that they will incur

REFERENCES

ADDIN EN .REFLIST Fixed Cost [Electronic Version] . Retrieved May 12 2007 from HYPERLINK "http /www .econ100 .com /eu5e /open /glossary .html www .econ100 .com /eu5e /open /glossary .html

Operating Leverage [Electronic (2007 . Version] . Retrieved May 12 , 2007 from HYPERLINK "http /www .investorwords .com /3462 /operating_leverage .html http /www .investorwords .com /3462 /operating_leverage .html

Variable Cost [Electronic Version] . Retrieved May 12 , 2007 from HYPERLINK "http /www .cfdccariboo .com /glossary .htm www .cfdccariboo .com /glossary .htm OPERATING LEVERAGE Page PAGE 2

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