Untitled Quiz

Study Notes

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.

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".

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.