ACC202 Assignments Week 2 - Discussion 2

In running an organization, information has to be made appropriate for decision-making. This, firsts and foremost, involves processing the raw data and coming up with presentable information in the form of statements. However, further analysis needs to be performed on the items of financial statements to provide an in-depth understanding of the relationships that exist between different items of the financial statements. Management uses this information to control the company strategy and monitor performance. This involves coming up with ratios and percentages that communicate the required information for management. Operating leverage is one such tool. It interrogates the relationship between an organization’s fixed cost and total cost.

In considering the illustration provided, management has to analyze what actions were taken by the enterprise in order to record the increase in sales revenue. Revenue is a top line item in the financial statements and is a priority item to all levels of management in business’ organization. The company may have recorded 12% in revenue as a result of different strategies that may be employed over the period under assessment. For example, this increase could have been as a result of increased direct marketing of products or introduction of a new platform for marketing such as an app or a website.

The impact to the top line revenue item may be the same, but the nature of these transactions is different within the organization, imposes different obligations and affects different accounts. This is where operating leverage comes in play. Fixed costs are covered by the contribution margin so as to get into profitability. As such, the pricing decisions and breakeven point vary. In organizations where fixed costs are high as compared to the total cost, then their operating leverage is high since it requires the organization to sell more units to cover the fixed cost. On the other hand, if the fixed costs are low in comparison to the total cost, then the operational leverage is low.

In considering the situation of Rovio, their product category is software. Development costs, which contribute greatly to the total cost greatly, are fixed in nature. As such, the sales level of their products (essentially games) will have to cover not just the variable cost but also the high fixed costs incurred for development. This is therefore an organization with high operating leverage. For investors, high operating leverage presents a higher risk as it fluctuates drastically from one period to another. Returns could be wiped out instantly.

Averkamp, Harold. “What Is the Difference between Revenues and Earnings?: AccountingCoach.” AccountingCoach.com, https://www.accountingcoach.com/blog/what-is-the-difference-between-revenues-and-earnings Links to an external site..

Bragg, Steven. “Operating Leverage.” AccountingTools, AccountingTools, 31 Dec. 2018, https://www.accountingtools.com/articles/2017/5/13/operating-leverage Links to an external site..

Pohjanpalo, Kati. “Furious Investors Dump Shares of Angry Birds Game Maker.” Bloomberg, 22 Feb. 2018, https://www.bloomberg.com/news/articles/2018-02-22/angry-birds-maker-rovio-falls-most-since-its-ipo-in-helsinki Links to an external site..

Warren, Carl S. “Chapter 11:Cost-Volume-Profit Analysis.” Survey of Accounting, 8th ed. Centage, www.cengage.com.