Dolph and Evan started the DE Restaurant in 20X3. They rented a building, bought equipment, and hired two employees to work full time at a fixed monthly salary. Utilities and other operating charges remain fairly constant during each month

During the past two years, the business has grown with average sales increasing 1% a month. This situation pleases both Dolph and Evan, but they do not understand how sales can grow by 1% a month while profits are increasing at an even faster pace. They are afraid that one day they will wake up to increasing sales but decreasing profits.

Required:
Explain why the profits have increased at a faster rate than sales. Use the terms variable costs and fixed costs in your response.

Answer: The fixed cost per meal served is decreasing with increased volumes, while the contribution margin per meal served remains constant. Apparently, most of the restaurant's expenses are fixed. Therefore, as sales pass the breakeven point the profit will increase even faster because the fixed expenses have already been covered. This allows sales to cover only variable expenses before contributing to the profit margin, thereby causing it to increase at a faster rate.