� Operational Gearing 2
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Operational gearing is the effect of fixed costson the relationship between sales and operating profits . If there isno operational gearing , then operating profit would rise at the same rate as sales growth ( assuming nothing else changed ).
� Operational gearing is simple and important - and often neglected .
� High fixed costs increase operational gearing .
Consider the following example :
1 . Two enterprises with different cost structures but the same profits
2 . Now suppose they both increase their sales by 50 %
Enterprise A Enterprise B Enterprise A Enterprise B
Sales 1,000,000 1,000,000 1,500,000 1,500,000
Variable Costs 700,000 800,000
( 700,000 + 350,000 ) 1,050,000
( 800,000 + 400,000 ) 1,200,000
Fixed Costs 200,000 100,000 200,000 100,000
Operating profit 100,000 100,000 250,000 200,000
As Enterprise A has higher operational gearing , it makes 2.5 × as much profit as it did before the 50 % increase in sales , whereas Enterprise B has only doubled its profits .
If you have time in the session , this could be a good exercise for participants to experiment with as it will contribute to sales / membership planning of the social start up and the potential profitability for it and its members .
If there is no time in the session , then do ask the Finance Team to work on this before the next Session .
2 This section is adapted from http :// moneyterms . co . uk / operational _ gearing /
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