The concept of operating leverage can explain the three percent decline in sales that caused the twenty-one percent decline in profits. Operating leverage is a measurement of the degree to which a firm incurs a combination of fixed and variable costs. Basically, operating leverage is a cost accounting formula that displays how well a company is utilizing its fixed costs to generate a profit. Managers use fixed costs as a level to achieve disproportionate changes between revenue and profitability. Furthermore, a business can have either a high or low operating level, which is influenced by either the volume of sales and contribution of margin or the proportion of fixed costs and variable costs. Therefore, the more profit a firm can generate …show more content…
The margin of safety assesses the cushion between budgeted sales and break-even sales. Furthermore, a break-even point identifies when an investment will generate a positive return. Therefore, it is where sales revenues minus variable and fixed costs generate zero profits (Kampf, Majerčák, & Švagr, 2016). The margin of safety calculates the sum by which actual sales can fall short of expectancies before a company will start undergoing deficits. In order to determine the margin of safety, break-even sales are deducted from budgeted sales and the variance is then divided by budgeted sales. Therefore, without a major change in the company’s fixed cost structure, a decline in the company’s sales will cause their net earnings to be closer to their break-even point, which in turn will effectively lower their margin of safety. Furthermore, a decrease in sales on the margin of safety will be unfavorable. Moreover, the reduction in sales reduces the contribution, thereby reducing net income and the end result is a decline in the margin of safety. Therefore, due to lower sales, Home Depot’s margin of safety will be lower if a change in budgeted sales is not implemented (Edmonds et al.,
Home Depot is the brainchild of Bernard Marcus and Arthur Blank and came about after both men lost their job in the home improvement industry in 1978 (Parnell, 2014). Home Depot has acquired several smaller home improvement stores in both the U.S. and abroad through the years which enabled it to position itself as the world’s largest home improvement chain (Parnell, 2014). Home Depot focuses on the do-it-yourself segment of the market and sells sells tools, construction products and services. Marketing is a strong point for the company. They are able to maintain a competitive advantage by keeping themselves available to their customers at all times. Home Depot has been using both online and offline marketing efforts. The internet has become a very useful tool for the company and part of the reason that they are leading the market in DIY stores. Home Depot currently provides DIY videos on YouTube and Vine that cover current topics that consumers are likely to be interested in. They also have social media pages on Facebook and Twitter, where they have a huge following. They provide online communities where actual employees answer consumer’s questions and provide assistance on
Home Depot operates in the home improvement retail industry that comprises of retailer that sell appliances, lumber, building material, kitten fittings and other home improvement products aimed at improving existing structures. Companies functioning in the home improvement industry buy products from retailer and manufacturer based all over the world, and then put those products for sale on the market to three types of buyers, generally characterized as: do-it-for-me, do-it-yourself, and professional customers. The home improvement retail industry is well established industry and is highly attractive and there is high level of price competition among the key players of the industry as the products lines are all the same.
The concept is useful when a significant proportion of sales are at risk of a decreasing, which may be the case when a sales contract is coming to an end. Therefore, a small margin of safety might prompt measures in which to reduce expenses. Margin of safety is especially useful in situations where huge segments of a company 's sales are at risk, such as when they are tied up in a single customer contract that may be canceled. In the case of Home Depot’s situation, as its revenue fell during the first six months of 2007, some of its costs probably fell as well; an example would be cost of goods sold. So for instance, if Home Depot was selling fewer goods, than it was purchasing hardly any goods as well. A prime example of how the decline in sales affected Home Depot’s margin of safety is with the depreciation charge for its stores and warehouses would probably not decrease as revenue fell, since these costs are fixed in connection to sales volume. Furthermore, not all costs are decreasing as sales decline, total expenses as a percentage of sales are rising, causing the percentage change in net earnings to decline faster than the percentage decline in sales. Unless there is some major change in a company’s fixed cost structure, a decrease in a company’s sales means that its net earnings will be closer to its break-even point, effectively lowering its margin of safety. LIkewise, margin of safety is the difference between budgeted sales and the break-even point, not actual sales and break-even sales. Thus, if Home Depot did not change its budgeted sales, one might contend that its margin of safety did not change, but realistically it has a lower margin of safety due to the lower
They raise the capital more easily and the interest rate would be much low. They employ expertise and specialist to manage its business and develop new products. The companies come response the market efficiently. And they design appropriate products for potential customers. It generates profits for the company.
...hese events happen or minimize the negative impact when they happened. This will stabilize the distributable profit.
Goods will be sold at that price at which:.. 1. More goods will be purchased and consumed. 2. More profits will be made. Thus goods will be sold at the most profitable price.
costing Marginal costing In product/service costing, a marginal costing system focuses on the behavioural, rather than the functional, characteristics of costs. It concentrates on separating costs into variable elements (where the cost per unit remains the same with total cost varying in proportion to activity) and fixed elements (where the total cost remains the same in each period regardless of the level of activity). Whilst this is not easily achieved with accuracy, and is an oversimplification of reality, marginal costing information can be very useful for short-term planning, control and decision-making, especially in a multi-product business. In a marginal costing system, sales less variable costs (regardless of function) measures the contribution that individual products/services make towards the total fixed costs incurred by the business.
The variables will have a mix of cost with profit, sales with profit or EBIT with EPS. Leverage helps to increase the profitability of the company with the use of fixed cost.
As can be seen from the graph all firms wishes to make maximum profit. Allocative efficiency is the best point, where Marginal cost equals to marginal revenue (Q3). All firm will like to have maximum profits where marginal cost while equals to marginal revenue (Q1). ...
The causes of the existence of such an advantage reflect the combined ability to recognize opportunity and therefore position the corporation accordingly, and produce what is wanted at a cost and therefore a price which is acceptable. Both these abilities are the result of the appropriate application of the core competencies possessed by the corporation.
...companies experienced in 2005 lower net profits than they did in the previous year of 2004, and they both also showed an increase in operating expenses, resulting in lower net profits. They both showed higher operating expenses in 2005 compared to 2004 and should modify or adjust their operations to help reduce expenses so that their profit margins will begin to increase.
well as the difference in the cost of the product and the profit it turns over is all
(f) How much will the firm produce in order to maximize profits at a price
A change in revenues can be caused by variations in selling price, sales volume or both. Therefore, the manager should consider the effects of reduction in selling price in both relative and absolute terms to understand the future prospects of the merger. The measure of profitability as a financial measure involves considering contribution and the net profits of the organization. Contribution refers to the difference between the total sales revenue and the variable expenses incurred to produce such revenues while divisional net profit refers to contribution less any proportion of common expenses such as administration, and marketing and distribution
It encourages competitiveness between companies as higher profit provides more opportunity to advance the company’s agenda (Codjia, 2014).