I am not able to understand this line :
Operating risk is affected by the relative mix of fixed and variable operating costs : the greater the fixed operating costs, relative to variable operating costs, greater the uncertainty of income and cash flows from operations and greater the operating Risk…WHY is uncertainty of income and cash flows increasing with increase in fixed operating cost and not variable operating costs…???
Uncertainty of income and cash flow is yet another factor that can increase operating risk. This is independent of t he proportion of fixed operating cost in overall operating cost.
In CVP analysis Profit = Contribution margin * units sold - Fixed cost .
Contribution margin is (Price- variable cost). i.e. If you incur high fixed cost and sell enough units to cover the fixed cost you are earning profit above the profit if you had incurred variable cost instead of fixed cost where the CM would have been lower. i.e. If you sell more you earn greater profit from incurring fixed cost as the variable costs will hit your CM lesser as the fixed cost has already been covered.
Instead if you sell less units you are better off with the Variable cost as you wont incur much loss and wont need to cover the additional fixed cost incurred to be profitable.
Degree of operating Leverage (DOL) is defined as % Change in EBIT/ % Change in Sales. This is greater if you incur a fixed cost vis- a -vis variable cost. Thats why if you have fixed cost your operating risk is greater.
Thank You…