Accounting For Dummies®, 4th Edition

9.6. Tucking Away Some Valuable Lessons

The P&L report template shown in Figure 9-1 offers managers several important lessons. Like most tools, the more you use it the more you learn. In the following sections I summarize some important lessons from the template.

9.6.1. Recognize the leverage effect caused by fixed operating expenses

Suppose sales volume had been 10 percent higher or lower in 2009, holding other profit factors the same. Would profit have been correspondingly 10 percent higher or lower? The intuitive, knee-jerk reaction answer is yes, profit would have been 10 percent higher or lower. Wouldn't it? Not necessarily. Margin would have been 10 percent higher or lower — $250,000 higher or lower ($25 margin per unit × 10,000 units = $250,000).

The $250,000 change in margin would carry down to profit unless fixed expenses would have been higher or lower at the different sales volume. The very nature of fixed expenses is that these costs do not change with relatively small changes in sales volume. In all likelihood, fixed expenses would have been virtually the same at a 10 percent higher or lower sales level.

NOTE

Therefore, profit would have been $250,000 higher or lower. On the base profit of $1.5 million, the $250,000 swing equals a 17 percent shift in profit. Thus, a 10 percent swing in sales volume causes a 17 percent swing in profit. This wider swing in profit is called the operating leverage effect. The idea is that a business makes better use of its fixed expenses ...