Question

A company has sales of $250000, contribution margin of $75000 and profit of $45000, with total fixed expenses amount to $30000. Variable expenses are 70% of sales.

1. What is its operating leverage?

2.What is its ratio of break-even sales to his current sales?

3. What is its safety-margin ratio to the target sales?

Answer 1

1. Operating leverage = Contribution margin / Profit = 75000 / 45000 = 1.67

2. Variable expenses = 0.7 * 250000 = $175,000

Contribution margin ratio = 75,000 / 250,000 = 0.3 or 30%

Break-even Sales = Total fixed costs / Contribution margin ratio

                             = 30,000 / 0.3

                             = 100,000

Ratio of break-even sales to his current sales = 100,000 / 250,000 = 0.4 or 40%

3. Margin of safety = Actual sales - Break-even Sales = 250,000 - 100,000 = $150,000
Safety-margin ratio to the target sales = 150,000 / 250,000 = 0.6 or 60%