Question

1. Explain why modern businesses tend to have higher levels of operating gearing than they did in the past.

thanks for any help:)

Answer 1

Solution:

To answer this question, firstly we need to understand, what is operating gearing ?

Operating gearing also called as operating leverage , effect if fixed costs in relationship between a business' sales and its operating profits.

The formula of operating leverage is

= fixed cost ÷ total cost

Thus , the higher the proportion of fixed cost in a business' total cost, the higher is the operating leverage.

Relationship of operating profits and sales with operating leverage:

A company have zero operating gearing ,when the operating profits will increase at the same rate of the growth in sales.

If a company have high operating leverage that means, the operating profits will increase at a higher rate than the growth in sales.

And the low operating leverage means that the operating profits will grow at lower rate than the growth in sales.

Having understand the term operating leverage ,now let's understand :

The reasons of modern business having high operating leverage than business in the past.

The simple reason of having higher operating leverage is to have a higher proportion of fixed costs in a business' total cost.

There can be Various reasons for the high fixed costs. For example,

1. High rent fixed cost :

In modern day business fixed costs are higher than variable cost because of high fixed rental cost of premises.

Rent of premises used to be low in past times as compared to modern days. That's why in past time business have low fixed costs and low operating leverage.

In past times business were started on owned premises as prices of properties were low. Nowadays most businesses are started on rented premises as property costs are so high . Thus the fixed operating costs are high in modern business as compared to the past.

2. Higher fixed salaries of staff :

Another reason for increased fixed cost and higher operating leverage can be higher fixed salaries of staff .

in the past , business used to have less professional staff and thus fixed salaries staff used to be low in the businesses ,

but nowadays business have higher fixed salary staff and thus fixed cause go high in proportion to variable cost.

( Finish )