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Purchasing and
selling prices
Structural
determinants
Volumes
Structural factors
Maximum
i
production
d i capacity
i
Experience
Specialization
Standardization
Industry
Vertical/horizontal integration
...
2
Price levels
Purchasing
h i prices
i
Price of inputs
p bought
g from suppliers
pp
Selling prices
Price
i off output sold
ld to consumers
Volumes
For ggiven structural determinants and cost
structure, the operating profits is determined by
volumes
Different volumes influence operating profits
by changing both total costs (via variable costs)
aandd revenues
eve ues
We use the break even point (BEP) analysis to
understand
d t d the
th relationship
l ti hi between
b t
volumes
l
and operating profits
Before BEP, lets recap the nature of costs
4
Costs
Costs
Volume range
being
considered
Total variable
costs
Volumes
a. linear relationship variable costs/volumes
Total variable
costs
Volumes
b. actual relationship variable costs/volumes
Costs
Costs
Volume range
being
considered
Volumes
a. linear relationship fixed costs/volumes
Volumes
b. actual relationship fixed costs/volumes
Costs
Total costs
V i bl costs
Variable
t
Fixed costs
Volumes
8
120
100
80
Average unit
cost cost
60
40
20
0
10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
Volumes produced
Example
Whatifonly30Kpiecessold(2/3ororiginalprojection)?
h f l
ld ( /
l
)
Average price per meal
16.00
720,000
4 00
4.00
16.00
480,000
4 00
4.00
120,000
80,000
130,000
210,000
60,000
70,000
35,000
30,000
-45,000
Example
Total and unit costs
(a)
Q
(b)
Variable
cost (VC)
per unit
(c)
Total VC
(a x b)
(000 )
(d)
Fixed
cost (FC)
(000 )
(e)
Total costs
(c +d)
000 )
(f)
Total cost
per unit
(e / a)
(g)
Fixed cost
per unit
(d / a)
25,000
4.00
100
405
505
20.20
16.20
30,000
4.00
120
405
525
17.50
13.50
45,000
4.00
180
405
585
13.00
9.00
60,000
4.00
240
405
645
10.75
6.75
16.00
Costs
and revenues
Sales
revenue
540,000
4.00
Operating
profit
135,000
210,000
Total
costs
540,000
60,000
Fixed
costs
General costs
70,000
Depreciation
35,000
Advertising
30,000
Operating income
0,000
Operating loss
BEP
33,750
Volumes
Operating risk
Varying degree of profitability that a firm will face
particularly negative or positive net income, in
relation to the fluctuation in production and sales
volumes
Linked to two components of the organization's
economic structure: BPE and degree of the operating
leverage
Operating leverage is the size of the differential
between revenues and total costs above and below the
bbreak-even
ea eve point
po t
Operating risk
Costs
and
d revenues
Sales revenue
Operating
p
g leverage
g
Total costs
Fixed costs
BEP
Volumes
Operating risk
Suppose that there are exogenous changes in volume:
g cost structure, i.e. high
g ratio of
If a firm has veryy rigid
fixed costs to total costs
The firm will react badlyy to drops
p in volumes ((less room to
distribute fixed costs over units of output)
But the same firm will respond positively to increases in
volumes
Operating risk
Profit point
So far, we have only focused on a BEP such
p
g costs ((e.g.
g labor,,
that revenues cover operating
equipment etc.)
But in practice firms incur in non-operating
non operating
costs related e.g. to financial charges and taxes
These charges are negative components that
need to be taken into account in the
determination of net income ( operating
income)
Profit p
point: example
p
Lets go back to the example of the restaurant (under scenario 1)
Average price per meal
16.00
Non-income taxes
6,000
50%
75,000
4.00
Target operating income
24,000
Financial charges
24,000+6,000+150,000
= 180,000
,
180,000
80,000
130,000