Question

Which of the following statements is true about the relationship between net operating income and sales?

1) Wider swings in net operating income as sales fluctuate
2) Greater profits in good years, greater losses in bad years
3) Higher operating leverage

Answer 1

The relationship between net operating income and sales can be described by the concept of operating leverage. Higher operating leverage means that a company's net operating income is more sensitive to changes in sales. Option 3) Higher operating leverage is the true statement about the relationship between net operating income and sales.

Step-by-step explanation:

The relationship between net operating income and sales can be described by the concept of operating leverage. Operating leverage refers to the degree to which a company's net operating income is affected by changes in its sales revenue. Higher operating leverage means that a company's net operating income is more sensitive to changes in sales.

Option 3) Higher operating leverage is therefore the true statement about the relationship between net operating income and sales. This means that as sales fluctuate, the company's net operating income will experience wider swings. When sales increase, the company's net operating income will increase at a higher rate, resulting in higher profits. However, when sales decline, the company's net operating income will decrease at a higher rate, resulting in greater losses.

For example, a company with high operating leverage may have high fixed costs (e.g., rent, salaries) and low variable costs (e.g., materials, labor). As a result, small changes in sales can have a significant impact on the company's net operating income.