Which effect describes purchasing expenditures decreasing while profits increase?

Which effect describes purchasing expenditures decreasing while profits increase?

• A. Profit Leverage Effect
• B. ROA Effect
• C. Inventory Turnover Effect
• D. Total Cost of Ownership

Answer: (A)

The main idea being tested is how cost reductions from purchasing can boost profits more than proportionally when fixed costs are a large part of total costs. This is the Profit Leverage Effect: cutting purchasing expenditures lowers only the variable portion of costs while fixed costs stay unchanged, so each saved dollar falls straight to the bottom line and can produce a larger percentage increase in profit, especially when fixed costs dominate. For example, suppose revenue is 100, fixed costs are 60, and purchases (variable costs) are 30, giving a profit of 10. If purchasing expenditures drop by 20% to 24, total costs fall to 84, and profit rises to 16. That’s a 6-dollar increase in profit from a 10-dollar baseline, a substantial, leverage-like boost. This illustrates why a seemingly modest cut in purchases can translate into a outsized rise in profit. The other options describe different financial effects that don’t specifically capture the idea of purchasing cost reductions magnifying profits through the fixed-cost structure. ROA relates to asset efficiency, inventory turnover to how fast inventory moves, and total cost of ownership covers all costs over a product’s life cycle.

The main idea being tested is how cost reductions from purchasing can boost profits more than proportionally when fixed costs are a large part of total costs. This is the Profit Leverage Effect: cutting purchasing expenditures lowers only the variable portion of costs while fixed costs stay unchanged, so each saved dollar falls straight to the bottom line and can produce a larger percentage increase in profit, especially when fixed costs dominate.

For example, suppose revenue is 100, fixed costs are 60, and purchases (variable costs) are 30, giving a profit of 10. If purchasing expenditures drop by 20% to 24, total costs fall to 84, and profit rises to 16. That’s a 6-dollar increase in profit from a 10-dollar baseline, a substantial, leverage-like boost. This illustrates why a seemingly modest cut in purchases can translate into a outsized rise in profit.

The other options describe different financial effects that don’t specifically capture the idea of purchasing cost reductions magnifying profits through the fixed-cost structure. ROA relates to asset efficiency, inventory turnover to how fast inventory moves, and total cost of ownership covers all costs over a product’s life cycle.