ACCA Financial Management (F9) Certification Practice Exam

What indicates the degree to which an organization's profits are made of variable costs?

1. Operational leverage

2. Operational gearing

3. Income variance

4. Cost structure

The correct answer is: Operational gearing

The concept that indicates the degree to which an organization's profits are made of variable costs is known as operational gearing. This refers to the relationship between fixed and variable costs within an organization and how changes in sales volume can affect profits. When an organization has high operational gearing, it signifies that a significant proportion of its costs are fixed, meaning that profits can increase significantly with a rise in sales. Conversely, if the organization has low operational gearing, it indicates that a larger proportion of its costs are variable, suggesting that profits may be less sensitive to changes in sales volume. Understanding operational gearing is crucial for financial management because it helps in analyzing how responsive a company's profitability is to changes in sales revenue. Companies with high operational gearing can benefit greatly during periods of growing sales, but they may also face risks during downturns, as fixed costs remain regardless of sales performance. This insight into cost structure dynamics is key for decision-making and financial planning.