1. Variable versus Fixed Costs
Understanding how costs behave in high and low sales environments

2. Characteristics differ between fixed and variable
Variable (as compared to volume)
Fixed (as compared to volume
Variable costs per unit do not change
Total variable costs increase as volume increases
Total variable costs decrease as volume decreases
Total fixed costs do not change as volume changes
Fixed cost per unit decreases as volume increases
Fixed cost per unit increases as volume decreases

3. Relevant Range of Activity
The estimated minimum and maximum volume likely to be achieved
Fixed costs are often a “step function” – relevant range allows total fixed costs to be locked in over the likely range of activity
Variable costs per unit would change over a large range of activity – relevant range allows a reasonable average to be calculated

4. To break out fixed from variable costs
All costs must be analyzed – sales, administrative, factory
Many costs are mixed, so must use math models high-low method, scattergraphs, regression analysis
The range of activity must be specified (relevant range allows total fixed costs and an average variable cost per unit )

5. Contribution Margin Income Statement
Sales Revenue
Less: Variable Costs
Equals: Contribution Margin
Less: Fixed Costs
Equals: Net Income
Contribution Margin Income Statement
A managerial statement allowing “what if’s.”
Not under U.S. GAAP
Often used for short run decisions

6. Magnitude of Operating Leverage ratio
Contribution margin Net Income Or
Sales-Variable costs
Net income
Sales – Variable costs Revenues - expenses
Magnitude of Operating Leverage ratio
A formula that shows company operating risk
higher # means more fixed costs
Lower # means more variable costs
High magnitude of operating leverage –small change in sales yields large change in profits
Low magnitude of operating leverage-small change in sales yields small change in profits
Profits are often more stable if company has lower levels of fixed costs