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Cost structure and profitability

1. What kind of effect does cost structure have on profitability?
2. In a poor economic environment (high level of uncertainty), what should a company do that only has fixed costs (no variable costs) in order to improve their level of profitability?

Solution Preview

Cost structure is a description of the proportion of costs that are variable versus fixed. Cost structure predicts how much the profits will shift for every change in sales. Here is an example:

Company A

Sales......................................$100,000
Variable costs.........................$20,000
................................................------------
Contribution margin.............$80,000

Fixed costs..............................$70,000
...............................................------------
Operating profit....................$10,000

"Degree of operating leverage": CM/OP = 80,000 / 10,000 = 8

Company B

Sales......................................$100,000
Variable ...

Solution Summary

Your tutorial is 393 words and gives you two examples to explain cost structure and how shifts in volume impact profits. There are not many options for off-loading fixed costs in a downturn which is why you don't lock in costs during uncertain times. That is why the recovery is SO SLOW. No one wants to lock in until they are sure and certainty can't come until folks lock in. A puzzle!

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