Cost-volume-profit analysis is a tool for analysing the financial characteristics of alternative production systems.
Focuses on how total costs and profits vary with output as the firm operates in a more mechanised manner and substitutes fixed costs for variable costs.
Operating leverage: reflects the extent to which fixed production facilities, as opposed to variable production facilities are used in the firm's operation.
Degree of operating leverage; percentage change in profit that results from a 1% change in units sold.
It is an elasticity concept as the elasticity of profits with respect to output.
When based on linear cost and revenue curves, this elasticity varies depending on the point of the breakeven graph being considered.
Degree of operating leverage is always greatest close to the breakeven point.
A small change in volume produces a large percentage increase in profits, because base profits are near zero.
For linear revenue and cost relations, the degree of operating leverage can be calculated at any level of output.
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