- Structural determinants
- production capacity
- economies of scale
- economies of learning
- economies of scope
- vertical integration
- industry
- volumes
- horizontal integration
- price levels (depend on: internal factors (power of suppliers etc) & external factors ( industry trends, competition levels))
- note on variable costs and fixed costs
variable: the linear relationship between variable costs and volumes we usually see s actually only referent to a volume range being considered
similarly happens to the fixed costs
- labor costs caveat
if labour can be easily decreased or increased or relocated across units then labor is a variable cost
however, in practise there may exist regulations & labour law that create hiring/firing fixed costs (or functions)
in that case, labor cost would entail a fixed cost component for our purpose we will assume labour is easily adjusted
- Operating Breakeven Point
Amount of sales that allow the firm to cover its operating costs
From where firms start to make an operating profit
- Contribution per unit
Net cash flow from a single transaction; the cash gained from an extra unit
CPU = Ru - VCu
- total contribution
net cash flow from a single transaction multiplied by total quantity of units
total contributuion = qt * CPU
- operating break-even point in qt (Qbep)
production volume to which total revenue are equal to cost
Qbep = FC / CPU
- Breakeven point in revenue
Contribution margins (or contribution % of sales or profit to volume ratio)
CM% = CPU/Ru = total cont/R
Rbep (sales version)
Rbep= FC / CM%
- what happens to graphs if
a) VC up
b) fixed costs down
a) BEP goes up
b) BEP goes down
- Operating Risk
better (smaller) with:
- small BEP
- large elasticity (degree of operating leverage)
- Degree of operating leverage
size of the wedge (gap) between revenues & total cost above and bellow BEP
- Firm has a rigid cost structure
- high rate of FC to TC
- it will react badly to drops in volume (less room to distribute fixed costs over units of output)
- firm will respond positively to growth in volume
- Firm has a flexible cost structure
- low rate of FC to TC
- if volume decreases, firm can easily decrease costs
- if volumes grow, firm experiences cost increase but sees less benefir in terms of revenue relative to a rigid structure
- Operating elasticity
= VCbep / FC = (VCu * Qbep) / FC
- Profit point volume and rev
sales volume that covers all costs & provides acceptable net income
Volume = (FC + Target oper income) / CPU
Revenue = (FC+ Target oper income) / CM%
