Question

During the most recent fiscal period, Cherokee Company had sales of $80,000. Variable costs are 20% of sales and fixed costs amounted to $48,000 for the year.

Calculate the following in Excel:

a. Contribution margin ratio

b. Operating leverage

c. Break-even sales in dollars

d. Using operating leverage, calculate the operating profit if sales increase by 20% next year.

Answer 1

Following are the calculations as required above.

	Formulae	Result	Formulae	Result(Amount)
Sales		100%		$80,000
Variabe cost	Given	20%	Sales*Variable cost%	$16,000
Contriution margin ratio/ Contribution	(Sales-variable cost)/Sales	80%	Sales-Variable cost	$64,000
Fixed cost			Given	$48,000
Operating profit ratio/ operating profit	(Contribution-Fixed cost)/Sales	20%	(Contribution-Fixed cost)	$16,000
Operating leverage	Contribution/Operting profit	4
Break even sales in dollar			Fixed cost/Contribution%	$60,000

Operating leverage is 4, that means 10% change in sales will increase the operating profit by 40% (i.e 4*10%).

If sales is increased by 20% then the operating profit will be increased by 80% (i.e 4*20%).

Operating profit after 20% increase in sales = $16,000+ ($16,000*80%) or $16,000*180%

=$28,800