Cost-Chapter 5

What is meant by the term operating leverage?

A measure, at a given level of sales of how percentage change in sales volume will affect profits. Computed by dividing the contribution margin at the level of sales by the NOI at that level of sales.

contribution margin ratio

A ratio computed by dividing contribution margin by dollar sales

**In all respects, Company A and Company B are identical except that Company A's costs are mostly variable, whereas Company B's costs are mostly fixed. When sales increase, which company will tend to realize the greatest increase in profits? Explain.

Company B will realize the greatest increase in profits because they have higher fixed costs and lower variable costs, therefore will have a higher contribution margin.

Often the most direct business decision is an incremental analysis. What is meant by an incremental analysis?

Focuses on the changes in revenues and costs that will result from a particular action.

margin of safety

The excess of budgeted or actual sales dollars over the break even volume of sales dollars. The amount by which sales can drop before losses are incurred.

variable expense ratio

a ratio computed by dividing variable expenses by dollar sales

What is meant by a product's contribution margin ratio?How is this ratio useful in planning business operations?

Contribution margin ratio is the percentage of sales, shows how the contribution margin will be affected by a change in total sales. ---Can be used in cost-profit calculations. Used in target profit and break even analysis and can be used to quickly estimate the effects on profits of a change in sales revenue.

**Explain how the shift in the sales mix could result in both a higher break even point and a lower net income

Could result if the sales mix shifted from high contribution margin products to low contribution margin products. Would cause the average contribution margin ratio in the company to decline, resulting in a less total contribution margin.

margin of safety

the excess of budgeted or actual dollar sales over the break-even dollar sales

Sales mix

The relative proportions in which a company's products are sold. Sales mix is computed by expressing the sales of each product as a percentage of total sales

Sales mix

The relative proportions in which a company's products are sold. The idea to achieve the combination or mix that will yield the greatest profits

operating leverage

a measure of how sensitive net operating income is to a given percentage change in dollar sales

degree of operating leverage

a measure, at a given level of sales of how a percentage change in sales will affect profits. The degree of operating leverage is computed by dividing contribution margin by net operating incme

target profit analysis

estimating what sales volume is needed to achieve a specific target profit

Break even point

the level of sales at which profits are zero