Financial management

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Vikram Aditya (Querist)
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04 February 2013 What will be Operating Leverage if,
sale price p.u. 20
variabe cost p.u. 6
fixed operating 80000
cost.

Assume no. of units sold is 5000.
Pls answer

Vikram Aditya

Vikram Aditya (Querist)
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04 February 2013 What will be Operating Leverage if,
sale price p.u. Rs20,
variabe cost p.u. Rs6,
fixed operating cost 80000
and assume no. of units sold is 5000.
Pls answer

Aashok Kumar Sharma online

Aashok Kumar Sharma online

(Expert)
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24 July 2024 Operating leverage measures the sensitivity of a company's operating income to changes in sales volume. It is calculated using the following formula:

\[ \text{Operating Leverage} = \frac{\text{Contribution Margin}}{\text{Operating Income}} \]

Where:
- **Contribution Margin** = \( \text{Sales} - \text{Variable Costs} \)
- **Operating Income** = \( \text{Sales} - \text{Variable Costs} - \text{Fixed Operating Costs} \)

Given the data:
- Sale price per unit (\( P \)) = ₹20
- Variable cost per unit (\( V \)) = ₹6
- Fixed operating cost (\( F \)) = ₹80K
- Number of units sold (\( Q \)) = 5,000 units

### Step-by-Step Calculation:

1. **Calculate Contribution Margin:**
\[ \text{Contribution Margin} = \text{Sales} - \text{Variable Costs} \]
\[ \text{Contribution Margin} = (P \times Q) - (V \times Q) \]
\[ \text{Contribution Margin} = (20 \times 5000) - (6 \times 5000) \]
\[ \text{Contribution Margin} = 1L - 30,000 \]
\[ \text{Contribution Margin} = ₹70,000 \]

2. **Calculate Operating Income:**
\[ \text{Operating Income} = \text{Sales} - \text{Variable Costs} - \text{Fixed Operating Costs} \]
\[ \text{Operating Income} = (P \times Q) - (V \times Q) - F \]
\[ \text{Operating Income} = (20 \times 5000) - (6 \times 5000) - 80,000 \]
\[ \text{Operating Income} = 1L - 30K - 80K \]
\[ \text{Operating Income} = -10,000 \]

(Negative operating income indicates a loss; however, for the purpose of operating leverage calculation, we proceed with the absolute values.)

3. **Calculate Operating Leverage:**
\[ \text{Operating Leverage} = \frac{\text{Contribution Margin}}{\text{Operating Income}} \]
\[ \text{Operating Leverage} = \frac{70K}{10K} \]
\[ \text{Operating Leverage} = 7 \]

### Interpretation:

An operating leverage of 7 indicates that for every 1% change in sales volume, the operating income will change by approximately 7%. Operating leverage amplifies the impact of changes in sales volume on operating income, which in this case is significant due to the relatively high fixed operating costs compared to variable costs. This sensitivity can lead to higher profitability in periods of increasing sales but can also magnify losses in periods of declining sales.

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