In the early 21st century, the economy was soaring causing people to use their money to have bigger and better homes, cars, and spending more money on discretionary items. Ideally, the job market was flourishing with people making more money than they have in years. Logically, this caused stores like Lowe’s, and Home Depot to sell more home building products than in previous years. Ironically, what goes up must come down, and in 2006, Home Depot saw a drop in sales which continued through 2007. In August 2007, Home Depot announced its revenues for the first half of the year dropped 3% from the same period in 2006. However, the worst part was their earnings for the first half of 2007 was 21% lower than the same period in 2006. Unfortunately, this situation can happen with the weakened economy causing executives to have to tighten down the ratchet on all expenses …show more content…
One way this can happen is by using the method of operating leverage. Cost structure condition that produces a proportionately more significant percentage change in net income for a given percentage change in revenue; measured by dividing the contribution margin by the net income and the higher the proportion of fixed cost to total costs, the higher the operating leverage (Edmonds, Tsay, & Olds, 2011). It is found that each firm has a natural rate of substitution at which it can increase fixed costs while lowering variable costs without any change in the degree of operating leverage or break-even point; however, it is possible to find a firm taking on higher levels of fixed costs with lower unit variable costs and have its degree of operating leverage and break-even point decrease (Lord, 1995). Consequently, Home Depot’s sales decreased while their earnings significantly reduced due to higher fixed costs which were negatived shaped due to the