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Sir, Could you explain this:-
If the operating gearing is low, the profits will be less sensitive to sales volume.
If the fixed cost element is reduced then wont the profit be more sensitive to sales volume?
Your second sentence is correct.
Your first sentence depends on how the operating gearing is measured, and there is no standard way of measuring it. If (for example) it were measured as fixed costs / variable costs, then the first sentence would be correct.
In the exam, if the examiner states how it is to be measured, then you do it his way and make the relevant comment.
If he doesn’t state, then you could measure it in various different ways (and still get the marks) and you will get the marks for commenting correctly on the way that you have measured it.Sir, this was in an MCQ.
Which of the following will be implied by the decrease in operating gearing?
A- Company is less profitable
B- Company is more risky
C- Company has lower proportion of costs which are variable
D- Company has profits which are less sensitive to sales volumeIf we use the formula of FC/VC for operational gearing then A, B and C can be eliminated which means that D is the right option. But I can’t understand how D is true.
Could you please explain this in detail?
It does not matter what comes out of any formula.
Just as with financial gearing, we say that more debt creates more gearing because of the fixed interest payments,
similarly, with operating gearing, more fixed payments mean more operating gearing.
If the fixed cost element is reduced then wont the profit be more sensitive to sales volume?
u have answered this as its correct
sir but isnt it if fixed cost element tht is operation gearing is high, a small % percentage in level sales could result in greater % changes in pbit
can u plz clarify it sir
thank you sm 🙂If there is lower operating gearing then there are fewer fixed costs and therefore changes in the sales results in a smaller change in the profits than if there was higher gearing.
Have you watched my free lectures on this?
but above you have told (i mean u agreed to it) tht reduced FC is “MORE” sensitive
no i havent watched your leacture sir, i had coaching in my college
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