Module+5000+XI.+Vocabulary

XI. Module 5000 Vocabulary MJH


 * Break-even point **: Break-even (or break even) is a point where any difference between plus or minus or equivalent changes side. []
 * Common fixed expenses **: Are the fixed costs that are not traceable to the segments and that would remain even if one of the segments was eliminated.

 It is calculated as follows:
 * Contribution margin **: A cost accounting concept that allows a company to determine the profitability of individual products.

 __Product Revenue - Product Variable Costs__  Product Revenue

 The phrase "contribution margin" can also refer to a per unit measure of a product's gross operating margin, calculated simply as the product's price minus its total variable costs.

 Consider a situation in which a business manager determines that a particular product has a 35% contribution margin, which is below that of other products in the company's product line. This figure can then be used to determine whether variable costs for that product can be reduced, or if the price of the end product could be increased. []  Formula: The following formula is used to calculate contribution margin ratio (CM ratio): CM Ratio = Contribution Margin / Sales CM ratio is extensively used in cost-volume profit (CVP) calculations. []
 * Contribution margin Ratio:** The contribution margin as a percentage of total sales is referred to as contribution margin ratio (CM Ratio).


 * Cost-volume-profit graph: **<span style="font-family: 'Times New Roman','serif'; font-size: 16px;">Depicts the relationship among cost, volume, and profits.


 * <span style="font-family: 'Times New Roman','serif'; font-size: 16px;">Degree of operating leverage: **<span style="font-family: 'Times New Roman','serif'; font-size: 16px;"> A type of leverage ratio summarizing the effect a particular amount of operating leverage has on a company's earnings before interest and taxes (EBIT). Operating leverage involves using a large proportion of fixed costs to variable costs in the operations of the firm. The higher the degree of operating leverage, the more volatile the EBIT figure will be relative to a given change in sales, all other things remaining the same. The formula is as follows:

<span style="font-family: 'Times New Roman','serif'; font-size: 16px;"> This ratio is useful as it helps the user in determining the effects that a given level of operating leverage has on the earnings potential of the firm. This ratio can also be used to help the firm determine the most appropriate level of operating leverage in order to maximize the company's EBIT. <span style="font-family: 'Times New Roman','serif'; font-size: 16px;">[] <span style="font-family: 'Times New Roman','serif'; font-size: 16px;">
 * <span style="font-family: 'Times New Roman','serif'; font-size: 16px;">Direct fixed expenses: **<span style="font-family: 'Times New Roman','serif'; font-size: 16px;">Fixed costs which can be traced to each segment and would be avoided if the segment did not exist.


 * <span style="font-family: 'Times New Roman','serif'; font-size: 16px;">Margin of safety **<span style="font-family: 'Times New Roman','serif'; font-size: 16px;">: Is how much output or sales level can fall before a business reaches its breakeven point. []

The items deducted will typically include [|tax expense], financing expense ( [|interest expense] ), and [|minority interest]. Likewise, [|preferred stock] dividends will be subtracted too, though they are not an expense. For a [|merchandising] [|company], subtracted costs may be the [|cost of goods sold] , sales discounts, and sales returns and allowances. For a product company [|advertising], [|manufacturing] , and design and development costs are included. []
 * Net income:** Is the residual [|income] of a firm after adding total [|revenue] and gains and subtracting all [|expenses] and losses for the reporting period. Net income can be distributed among holders of common stock as a [|dividend] or held by the firm as an addition to [|retained earnings] . As [|profit] and [|earnings] are used synonymously for [|income] (also depending on UK and US usage), net earnings and net profit are commonly found as synonyms for net income. Often, the term income is substituted for net income, yet this is not preferred due to the possible ambiguity. Net income is informally called the bottom line because it is typically found on the last line of a company's [|income statement] (a related term is [|top line], meaning [|revenue] , which forms the first line of the account statement).


 * Operating income:** The amount of profit realized from a business's operations after taking out operating expenses - such as cost of goods sold (COGS) or wages - and depreciation. Operating income takes the gross income (revenue minus COGS) and subtracts other operating expenses and then removes depreciation. These operating expenses are costs which are incurred from operating activities and include things such as office supplies and heat and power. Operating Income is typically a synonym for earnings before interest and taxes (EBIT) and is also commonly referred to as "operating profit" or "recurring profit".

Calculated as: Operating Income = Gross income - Operating Expenses - Depreciation

<span style="font-family: 'Times New Roman','serif'; font-size: 16px;"> Operating income would not include items such as investments in other firms, taxes or interest expenses. In addition, nonrecurring items such as cash paid for a lawsuit settlement are often not included.

<span style="font-family: 'Times New Roman','serif'; font-size: 16px;"> Operating income is required to calculate operating margin, which describes a company's operating efficiency. []


 * <span style="font-family: 'Times New Roman','serif'; font-size: 16px;">Operating Leverage: **<span style="font-family: 'Times New Roman','serif'; font-size: 16px;">A measurement of the degree to which a firm or project incurs a combination of fixed and variable costs.

<span style="font-family: 'Times New Roman','serif'; font-size: 16px;"> A business that makes few sales, with each sale providing a very high gross margin, is said to be highly leveraged. A business that makes many sales, with each sale contributing a very slight margin, is said to be less leveraged. As the volume of sales in a business increases, each new sale contributes less to fixed costs and more to profitability.

<span style="font-family: 'Times New Roman','serif'; font-size: 16px;"> A business that has a higher proportion of fixed costs and a lower proportion of variable costs is said to have used more operating leverage. Those businesses with lower fixed costs and higher variable costs are said to employ less operating leverage.

<span style="font-family: 'Times New Roman','serif'; font-size: 16px;"> The higher the degree of operating leverage, the greater the potential danger from forecasting risk. That is, if a relatively small error is made in forecasting sales, it can be magnified into large errors in cash flow projections. The opposite is true for businesses that are less leveraged. A business that sells millions of products a year, with each contributing slightly to paying for fixed costs, is not as dependent on each individual sale. <span style="font-family: 'Times New Roman','serif'; font-size: 16px;">[]

<span style="font-family: 'Times New Roman','serif'; font-size: 16px;">It shows the break-even point by depicting revenue, cost, and profit relationships over a range of activity. This representation allows one to view the relative amount of important variables at any graphed volume.
 * Profit-volume graph:** Portrays the relationship between profits and sales volumes. A Cost-Volume-Profit graph (CVP) illustrates the relationships among
 * <span style="font-family: 'Times New Roman','serif'; font-size: 16px;">Activity volume
 * <span style="font-family: 'Times New Roman','serif'; font-size: 16px;">Total revenues
 * <span style="font-family: 'Times New Roman','serif'; font-size: 16px;">Total costs
 * <span style="font-family: 'Times New Roman','serif'; font-size: 16px;">Profits

<span style="font-family: 'Times New Roman','serif'; font-size: 16px;"> Profits are represented by the difference between total revenues and total costs. As unit sales increase, the contribution margin first goes to cover the fixed costs. Beyond the break-even point, any additional contribution margin provides a profit.

<span style="font-family: 'Times New Roman','serif'; font-size: 16px;"> When management is primarily interested in the impact of changes in sales volume on profits and less interested in the related revenues and costs, a profit-volume graph is sometimes used. <span style="font-family: 'Times New Roman','serif'; font-size: 16px;">[] <span style="font-family: 'Times New Roman','serif'; font-size: 16px;"> <span style="font-family: 'Times New Roman','serif'; font-size: 16px;">[]
 * <span style="font-family: 'Times New Roman','serif'; font-size: 16px;">Relevant range: **<span style="font-family: 'Times New Roman','serif'; font-size: 16px;">The range of [|activity] within which assumptions about [|variable] and [|fixed cost] behavior are valid. Also known as the current operating range.

Selling less of a more profitable product but making up the sales with a less profitable product still leaves one with lower profits. <span style="font-family: 'Times New Roman','serif'; font-size: 16px;">[]
 * Sales mix:** A sales mix is the proportions of sales coming from different products or services. Changes in sales mix often affect profits because different products often have different profit [|margins], therefore a change in the sales mix can have an impact on profits even if total revenues are unchanged.


 * <span style="font-family: 'Times New Roman','serif'; font-size: 16px;">Sensitivity analysis: **<span style="font-family: 'Times New Roman','serif'; font-size: 16px;">A technique used to determine how different values of an independent variable will impact a particular dependent variable under a given set of assumptions. This technique is used within specific boundaries that will depend on one or more input variables, such as the effect that changes in interest rates will have on a bond's price.

<span style="font-family: 'Times New Roman','serif'; font-size: 16px;"> Sensitivity analysis is a way to predict the outcome of a decision if a situation turns out to be different compared to the key prediction(s).

<span style="font-family: 'Times New Roman','serif'; font-size: 16px;"> Sensitivity analysis is very useful when attempting to determine the impact the actual outcome of a particular variable will have if it differs from what was previously assumed. By creating a given set of scenarios, the analyst can determine how changes in one variable(s) will impact the target variable.

<span style="font-family: 'Times New Roman','serif'; font-size: 16px;"> For example, an analyst might create a financial model that will value a company's equity (the dependent variable) given the amount of earnings per share (an independent variable) the company reports at the end of the year and the company's price-to-earnings multiple (another independent variable) at that time. The analyst can create a table of predicted price-to-earnings multiples and a corresponding value of the company's equity based on different values for each of the independent variables. []


 * Variable cost ratio:** Variable costs expressed as a percentage of sales. The variable cost ratio compares costs, which fluctuate depending on production levels, to the revenues made on those products. This ratio relates the specific costs to the revenues they generate.

May also be defined as "1 - contribution margin ratio".

<span style="font-family: 'Times New Roman','serif'; font-size: 16px;"> The variable cost ratio is useful in setting pricing policy so as to arrive at the optimum price for a product. The calculation can be done on a per-unit produced basis, or by totals over a time period as long as the numerator and denominator are used.

<span style="font-family: 'Times New Roman','serif'; font-size: 16px;"> For example, if variable costs per unit of a product are $55 and the product sells for $100, the variable cost ratio is 55%. The difference between the selling price and variable costs is known as contribution margin (CM); this amount is the contribution toward meeting fixed costs. The variable cost ratio can also be computed as (1 - CM ratio). <span style="font-family: 'Times New Roman','serif'; font-size: 16px;">[]