In this workout a retailer has disclosed information about their cost base and we're asked a classify the costs as fixed or variable costs. We're then asked to use this information to estimate how a 10% increase in revenues impacts on EBITDA and EBITDA margin. Firstly let's classify the cost base of the retailer and we'll start with cost of goods sold. These reflect the amounts of goods sold in a period so if revenues increase these will definitely increase as well. And therefore we usually treat these as a variable cost. Next is labor costs, although these can be variable for example staff commissions and bonuses the majority of staff are on fixed salaries. So in the short term, at least they're treated usually as a fixed cost.

Next is advertising costs, there's usually a strong link between revenues and advertising spend, an example of this was seen during covid where lots of consumer companies cut their advertising spend during covid lockdowns to help manage the impact of revenue falls on their profitability.

Therefore we'd usually treat these as variable. So if the company has plans but a big upcoming marketing campaign we might need to take this into account in our forecasts.

Next is other operating costs. Now, we clearly don't have much information here. But we do know that this sits within selling general and admin costs since cost of goods sold are disclosed separately above so this is likely to include a lot of head office costs, which don't relate to staff salaries. For example property maintenance, audit fees Etc. These are likely to be relatively fixed costs as they aren't related to business activity. So we'll assume that they are indeed fixed. Now that we've classified the cost base we can flex the EBITDA and EBITDA margin for a 10% increase in revenues. Let's scroll down for that.

Firstly let's calculate our revised revenue figure. And i'll lock my reference to revenue increase so I can reuse this formula.

And I'm then going to reuse that formula for all of my variable costs. So if my sales go up by 10% then all my variable costs will go up by 10% Meanwhile my fixed costs are not going to change so I'm just going to link those to the rows above.

Let's now calculate my revised EBITDA. That's my sales less my costs giving revised EBITDA of 234 and I can use that to calculate the revised margin of 23.9%.

Now notice that's higher than before and that's because the fixed costs unchanged even when revenues increase. Now what we can also do is calculate the degree in operating leverage. This is the percentage change in our profit measure that's a bit dark relative to the percentage change in revenues the percentage change in our profit measure. The percentage change in our EBITDA is a revised EBITDA, compared with the previous figure and that's a 17% increase in EBITDA. So we have a 17% increase in our EBITDA compared with a 10% increase in our revenues. That's 170% degree in operating leverage. So that tells us that for every 1% change in revenue are EBITDA will increase by 1.7 times this. But what does this all mean when we're forecasting margins? Well, let's see what happens. If we increase the proportion of fixed costs. Let's instead assume. The advertising costs are fixed costs. This means that instead of increasing by 10% with revenues that instead is going to be linked to the previous figure.

This means our degree of operating leverage has now increased and our revised EBITDA margin is even higher than before.

So companies with a high level of fixed costs. Will see a high level of margin expansion when revenues are increasing but then let's see what also happens if we change our revenue increase to a negative figure - 10% We can also see there's a dramatic fall in the company's EBITDA and EBITDA margin. So companies with a high level of fixed costs will also see a high level of margin contraction when revenues are falling.