Financial Management - Operating and Financial Leverage

October 30, 2021

Leverage = represents the use of fixed costs

Variable Costs Manufacturing costs = Direct Materials, Direct Labor, Manufacturing Overhead

Fixed Costs ex. Rental, Depreciation - Machinery, Salary (Utilities, Supervisors, Manager)

1 CVP Analysis ( Cost Volume Profit Analysis) (Standard - Income Statem

Per unit Total
units sold 10,000
Sales P 10 P 100,000 100% Sales
Less: Variable cost 3 30,000 30% Less; Cost of Sales
Contribution Margin 7 P 70,000 70% Gross profit on sales
Less; Fixed Costs 25,000 Less; Selling and Administ
Net income P 45,000 Net income before tax
Less; Tax
Net Income after tax

I- CVP Analysis for Break-Even Planning

Break-even point is the level of sales volume where total revenues and total expenses are equal
that is, there is neither profit or loss.

1-a Break-even point (units) Total Fixed Costs

=
Contribution Margin per unit

1-b Break-even point (peso) Total Fixed Costs

=
1 - Variable Costs
Sales

1-c (a) Break-even sales for Total Fixed Costs

=
multi-products firm Weighted Average CM
(combined units )

1-c (b) Weighted Contribution Margin Unit CM x no. of units per mix + Unit CM x no. of units per mix
per unit Total no. of units per sales mix

1-d (a) Break-even sales for Total Fixed Costs

=
multi-products firm Weighted CM ratio
(combined pesos)

1-d (b) Weighted CM ratio Total Weighted CM (P)

=
 =
Total Weighted Sales (P)

II - CVP Analysis for Revenue and Cost Planning

Used to determine the level of sales needed to achieve a desired level of profit

1 Sales (units) = Total Fixed Costs + Desired Profit

CotributionMargin per unit

2 Sales (Peso) = Total Fixed Costs + Desired Profit

CotributionMargin Ratio

III - Sales Mix

Refers to relative proportion in which a company's products are sold.

IV - OPERATING LEVERAGE
(a)It is a measure of how sensitive net operating income is to a given percentage change in peso sales.
(b) If operating leverage is high, a small percentage increase in sales can produce a much larger
percentage increase in net operating income.

Illustration:
Case A Case B
Present Expected Present Expected
Sales 100,000 110,000 100,000 110,000
Variable expenses 60,000 66,000 30,000 33,000
Contribution Margin 40,000 44,000 70,000 77,000
Fixed expenses 30,000 30,000 60,000 60,000
Net Operating income 10,000 14,000 10,000 17,000

1 Degree of operating leverage Contribution Margin

=
Net operating income

2 Degree of operating leverage Percent Change in operating income

=
Percent change in unit volume

TheDOL for the two farms at P100,000 sales would be computed as follows:
Case A P40,000
=
P10,000 4

Case B P70,000
=
P10,000 7
 Percent Increase DOL Percent Increase
In sales in Net Operating Income
(1) (2) (1) x (2)
Case A 10% 4 40%
case B 10% 7 70%
facturing Overhead

visors, Manager)

(Standard - Income Statement)

Less; Cost of Sales

Gross profit on sales
Less; Selling and Administrative Expenses
Net income before tax

Net Income after tax

units per mix

Illustrations:
Illustrative Problem:

(1) Havana Village Association is planning another Riverboat Extravaganza. The committee has assembled the following ex
costs for the event.

Dinner (per person) P 7 VC

Favors and program (per pserson) 3 VC
Band 1,500
Tickets and advertising 700
FC
Riverboat rental 4,800
Floorshow and strolling entertainers 1,000

The committee members would like to charge P30 per peron for the evening's activities.

Q1 - Compute for the break-even point for the Extravaganza ( in terms of the number of persons that must attend)

Sales = Variable expenses + Fixed expenses + Profit

P30 Q = P10Q + P8,000 + 0
P30 Q - P10Q = P8,000
P20Q = P8,000
Q= P8,000
20
Q= 400 persons

in Peso = 400 x P30 = P12,000

Q2 - Assume that only 250 persons attended the Extravaganza last year. If the same number attends this year, what price p
must be charged to break even?

Sales ? 42 VC 10
Less: VC 10 FC =P8,000/ 250 32
CM 20 Ticket price at 250 42
Less: FC 8000
Profit (Loss) 0

(2) Omega Enterprises sells two products, Model E100 and F900. Monthly sales and the contribution margin ratios for the
two products, follow:
Product
E100 F900 Total
Sales P 700,000 300,000 1,000,000
CM ratio 60% 70% ?

The company's fixed expenses total P598,500 per month.

Q1- What is the company's total CM ratio?

E100 F900
Amount % Amount %
 Sales 700,000 100% 300,000 100%
Less: VC 280,000 40% 90,000 30%
CM 420,000 60% 210,000 70%

Less: Fixed Expenses

NET INCOME

Q2 - Compute the break-even point in peso.

BE point in Peso = FC 598,500

Overall CM ratio 63%

BE point in Peso = = 950,000

as assembled the following expected

sons that must attend)

Sales 30
Less: VC 10
CM 20
Less: FC 8000
Profit (Loss) 0

attends this year, what price per ticket

tribution margin ratios for the

Total
Amount %
1,000,000 100%
370,000 37%
630,000 63%

598,500

31,500