A business often can choose between a high level of fixed assets and a lower level of fixed assets. If labor is not replaced with equipment, fixed costs are held lower, and variable costs are higher. With a lower level of operating leverage, the business shows less growth in profits as sales rise, but faces less risk of loss as sales decline. As with Lillian's Bakery, as sales exceed 70,000 bird calls, Joe's Carpentry Shop earns a profit. Sales of less than 70,000 bird calls produce a loss.
Similar losses occur as sales drop below break-even.
If we compare Lillian's Bakery in the first example and Joe's Carpentry Shop in the second example, it is apparent that Lillian's Bakery will benefit more from increased sales than will Joe's Shop. On the other hand, the higher degree of operating leverage in the bakery will cause Lillian's to suffer greater losses on sales declines. Breakeven analysis shows the effect of increased investments in fixed assets that lower variable costs but increase fixed costs. A decision to go with heavier investment in fixed assets and to increase operating leverage will, to a large extent, be determined by your perception of the economy and of the ability of your business to meet higher sales levels necessary to support the fixed costs. Also consider the degree to which sales expansion is practical.