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John Moffat.
John Moffat.-
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aarina
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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?
John Moffat
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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.
aarina
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Oh i understand perfectly now thank you! 🙂
John Moffat
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You are welcome 🙂
aarina
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