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c. The profitability of an activity can be easily estimated in relation with the contribution margin and break-even point of the respective activity. Indeed, first of all, the contribution margin, calculated as sales revenue less variable cost related to the specific activity, will tell us whether or not such an activity is bringing a profit for the company. Besides variable costs, one needs to take into consideration fixed costs associated with that activity, as well as any opportunity costs that may occur, due to the use of company resource for the activity at hand rather than for something other profitable activity.
The break-even point completes the contribution margin concept and helps discover the exact number of units that must be sold so that sales revenues will equal total costs. By performing a break-even analysis, the company will be able to determine whether or not it is able to produce the required number of units needed to make the activity profitable.
The operating leverage helps determine the extent to which fixed costs are included in the total costs of a company and influence the profit variations. Indeed, fixed costs do not vary according to the activity of the company. This means that, for a particular sale, if the proportion of fixed costs is sufficiently high and the variable costs low, the profits will not be determined by the variable costs and will thus remain at a higher level.
Fixed and variable costs are the main elements that form the company's short-term liabilities and have to be taken into consideration when estimating a company's profitability. Given the fact that, generally, one cannot influence the fixed and administrative costs, the important issue becomes how one can manipulate variable costs so that it will achieve the highest profit at a given level.
In my opinion, the three learning points that have been previously mentioned are important because they define means by which an activity within a company can be judged profitable or unprofitable and represent, from a financial point-of-view, the argumentation for a yes/no decision on whether to pursue a certain activity or not. In the end, concepts like contribution margins or break-even point resume to an explicit figure that will provide the basis for a decision.
d. I have used to Wal-Mart 2003 Financial Report, specifically the consolidated statements of income, where revenues and costs and expenses are mentioned, as compared to the value obtained for 2001 and 2002.
In 2003, Wal-Mart obtained net revenue from sales in amount of $244,524 millions, as compared to $217,799 and $191,329 in the previous two years. As compared to 2002, the net revenue from sales increased with 10.9%. The costs of expenses were identified as cost of sales (variable costs) and operating, selling and general and administrative expenses (fixed costs). In 2003, variable costs amounted for $191,838, while fixed costs were $41,043. Net operating profit in 2003 was $13,644 million, 14.3% higher than in 2002.
The contribution margin, as applied to 2003, was $52,868 million, while the net operating profit shows a consistent performance on behalf of the company. In this sense, an overlook of the Wal-Mart 2003 Report shows that the variable costs of the company have increased somewhat proportionally to the net sales revenues, which seems reasonable given the fact that variable costs are associated within sales. Compared to 2003, net revenues have increased with almost 11%, while variable costs increased by 11.8%. While this is not yet a worrying conclusion, corroborated with an increase in fixed costs as well, an operating decision for the following year will need to take into consideration the fact that costs seem to rise more than the sales revenue may lead in the future to an increase the break-even value to a point whether the company will not be able to cover it. As such, a more prudent cost policy is advisable in this case, one which will better correlate company revenues with costs needed to achieve those operating…[continue]
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