Untitled Quiz

Break-even Point (BEP)

• The break-even point (BEP) is the point where total costs equal total revenues.
• At the BEP, there is no profit or loss for the business.
• The BEP helps understand the impact of cost structure on profitability.

Operating Risk

• Operating risk is determined by the degree of flexibility in a company's cost structure.
• Flexibility index is calculated by dividing variable costs (VC) by fixed costs (FC) - a higher ratio indicates a more flexible cost structure.
• Flexible cost structure:
  • Low fixed costs relative to total costs.
  • Low break-even point, making it less risky.
  • Limited losses before break-even and limited profits after break-even.
• Rigid cost structure:
  • High fixed costs relative to total costs.
  • Higher risk but profits increase rapidly after break-even.
  • Rigid cost structures are more risky because if volumes drop, the firm loses money.
• Operating leverage is the difference between revenues and total costs above and below the BEP. - Higher leverage equals higher operating risk which can be amplified by how far the company is from the BEP and the operating elasticity.
• Operating risk can be beneficial because it can amplify profits as well.
• Startups are encouraged to have a high incidence of variable costs to reach BEP as soon as possible.

Volume Economies & Scale Economies

• Capacity is the maximum output that can be produced in a given time period.
• Maximum production capacity (MPC): The maximum capacity of production for given time period.
• Current production capacity (CPC): Units of output currently being produced in a given time period.
• Degree of utilization: Ratio of CPC to MPC (actual output vs. potential output).
• Efficiency drives cost savings through "economies of learning".

Cost Structure and Break-even Point

• Variable costs vary with the volume of production.
  • The higher the volume produced, the higher the total variable costs.
  • The relationship between variable costs and volumes is not linear.
  • Discounts on purchases and increases in efficiency can reduce the variable cost unit.
• Fixed costs do not vary within a given interval of production.
  • They depend on production capacity.
  • They are not completely fixed, and can increase by steps as volume reaches the limit of production capacity.
• Cost structures dominated by variable costs are defined as flexible because they adapt easily to changes in volume.
• Cost structures dominated by fixed costs are defined as rigid as they have difficulty adapting to changes in volume.
• Total operating costs equal Fixed Costs + (Variable Costs x Volume Produced).
• Non-operating costs are associated with financial operations, investments, and taxes.
• Discretionary costs can be curtailed or eliminated without immediate impact on short-term profitability.