Question

What is Cost-Volume-Profit analysis and how might it be used?

Explain Margin of Safety and how it is calculated.

Compute the Contribution Margin and describe what it reveals about a company’s cost structure.

What is Operating Leverage and how is it used to analyze changes in sales and profitability?

Answer 1

Solution. Cost-Volume-Profit analysis shows relationship between varying levels of costs and volumes impacts on company's operating profit and facilitates in economic decision making for budgeting and profit planning and provides with sales data to eliminate future losses.  

Margin of Safety = Actual Sales - Break Even Sales

An organization exists to earn profit and eliminate losses. MOS provides with a measure of the amount over break-even point below which the organization will start to incur loss.

It reveals another aspect about the company's revenue position after covering variable costs to meet other requirements. It facilitates in decision making by refering the contribution it will add to the decision taken for the company. It is computed by the below given formula:

Contribution Margin= Revenue - Variable Costs

Operating Leverage provides with the measure of degree of increase in company's operating income by increasing revenue. If a company has high degree of operating leverage it refers it is carrying out sales with high gross margin(net sales revenue - cost of goods sold) as it reflects its cost structure and entertains risk and less flexibility. Similarly, a company with low degree of operating leverage has lower impact with changes in sales revenue figure and enjoys a smaller profit.