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Operating gearing

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA PM Exams › Operating gearing

  • This topic has 3 replies, 2 voices, and was last updated 7 years ago by John Moffat.
Viewing 4 posts - 1 through 4 (of 4 total)
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  • July 4, 2018 at 4:54 pm #460963
    aarina
    Member
    • Topics: 71
    • Replies: 145
    • ☆☆☆

    Hi may can you explain why/how does the fixed cost makes profit more volatile as PBIT becomes more vulnerable to downturns in business volume?

    July 5, 2018 at 6:53 am #461006
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54701
    • ☆☆☆☆☆

    This is more relevant to the FM exam (old Paper F9).

    Suppose the revenue is 100,000, the variable costs are 40,000 and the fixed costs are 20,000. The profit is therefore 40,000.

    Suppose the sales volume falls by 20%. The revenue will fall by 20% to 80,000; the variable costs will fall by 20% to 32,000; but the fixed costs will stay the same at 20,000. The profit is therefore 28,000.

    So, even though the volume has fallen by only 20%, the profit has fallen by 12,000, which is a fall of 12,000/40,000 = 30%

    Try it with bigger fixed costs and you will find that the more the fixed costs, the more the profit falls for a fall in volume – it is more volatile.

    July 5, 2018 at 8:47 am #461021
    aarina
    Member
    • Topics: 71
    • Replies: 145
    • ☆☆☆

    Oh i understand perfectly now thank you! 🙂

    July 5, 2018 at 9:09 pm #461063
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54701
    • ☆☆☆☆☆

    You are welcome 🙂

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