- This topic has 3 replies, 2 voices, and was last updated 7 years ago by
.
- Posts
Sir there is a question in kit that board of freedling co are in discussion about the various risk types that face the business. It is evident that there is a considerable confusion and disagreement.
Operating risk
Some of the directors feel that given the increasing volume of trade having fixed costs is the best thing to do. How can it be risky to have fixed costs when we know how much they are and that they don’t change overly much from 1 year to the next was one comment. there was also a discussion about changing the cost structure. It was thought that this would be difficult as most staff , e.g, were paid a salary and moving them on to an hourly rate would be opposed by them.
Gearing risk
The directors were more aware in this area with some favoring a more traditional view of gearing and others remembering M & M fondly from their studies.
Which Is the following statement true for operating gearing.
Variable cost are risky because they change as volume changes. Given freedling is growing the year on year variable cost level has changed a lot as well.
Sir the above statement is false, but can you please explain me this?
Variable costs are risky, but what matters is the riskiness of the profits.
As the variable costs change with the volume, so too will the sales revenue. So the contribution will vary, but the fixed costs will make the profits even more risky (as explained with the illustration in my free lecture on this).
So sir here what question is trying to ask is that as far as operating gearing is concerned, is variable cost risky, so this statement is false because as far as operating gearing is concerned it is fixed cost which is more risky.? Right?
But read what the director has said and think about it.
He/she is right to say that variable costs in total will change, but fixed costs will stay the same.
However (yet again as explained in my lecture) more fixed costs make the profits more risky and that is what matters to the company.
- The topic ‘Freedling—gearing risk’ is closed to new replies.