You own a chain of retail boutiques specializing in organic, gourmet enemas. You own the buildings your stores operate in, making you a prime candidate for an opco/propco situation.
In the opco/propco structure, a company's interests get divided into two segments. There's a company that owns all the real estate...that firm is known as the property company, or "propco." Meanwhile, you've got a separate entity that runs the actual business. It's referred to generally as the operating company, or "opco."
By separating the businesses, you take advantage of different legal requirements and debt structures. The property company has all that real estate...collateral it can use to take on additional debt. You use that to lever up the propco...leaving the opco relatively debt free, meaning it has a strong credit rating and doesn't spend much of its revenues on debt service (though it does have to pay rent to the propco as part of the deal).
Meanwhile, since the propco only deals in real estate, it's potentially eligible to organize as a real estate investment trust, or REIT. That structure gives it a significant tax advantage when it comes to income distributions.
Related or Semi-related Video
Cost Accounting: How Does Operating Leve...1 Views
and finance Allah shmoop How does operating leverage work for
high margin versus low margin companies All right people While
every company has two basic kinds of costs variable and
fixed well variable cost change with the number of items
you produced each hamburger has a certain amount of meat
in it Make more hamburgers Use more meat That's a
variable cost Fixed costs remain constant No matter how many
items you make the rent on your hamburger stand is
the same No matter how many hamburgers yourself Like your
rents 10 grand a month it's 10 grand If you
sell one hamburger it's 10 grand If you sell 1,000,000
hamburgers the cost is fixed Operating leverage seeks to take
advantage of the fixed nature of those fixed costs Since
they don't go up as production increases like they're a
freebie you get a cost benefit from producing Mohr stuff
Make one hamburger and that becomes a very expensive hamburger
to produce Better get at least 10 grand for it
and change it if you want to keep the doors
open Therefore going bankrupt because your production was so low
you spent $10,000 in rent You asked to sell that
single hamburger But if you sell 1,000,000 burgers well then
your per burger cost of rent was much much lower
the rent cost And for each burger drops table just
a penny It's almost negligible You spread the cost of
that rent over a very large number of products and
the per item cost of the product gets relatively way
smaller Well the impact of this dynamic appears on your
financial statements as better operating margin mohr of the revenue
you produce falls to the operating profit line so operating
leverage is great But unfortunately not all companies are well
positioned to take advantage of it Some situations air friendlier
to operating leverage than others specifically operating Leverage works best
in situations with high gross margin unit products and low
variable expenses Like basically the higher mix of your expenses
that come from the fixed category Will the more room
you have to take advantage of operating leverage Alright let's
walk through an example Here you founded a company in
your garage that makes windshield wipers You think you've figured
out a better way to push water off of glass
and you expect to become the Steve Jobs of the
automatic squeegee industry However you quickly find out that you've
entered a tough business a lot of competition Your design
is 10% better than other products but customers don't really
care You couldn't get financing so you're making the wipers
by hand in your own garage You sell the wipers
for 25 bucks each but between your labour and the
supplies each item has variable cost of $23 each So
you only get a $2 gross profit from each sale
a measly 8% gross profit margin for each wiper sold
But you're working out of your garage stealing your neighbor's
WiFi and selling your orders online so your overhead costs
are almost nil Good news kind of in terms of
your expenses there But taken together your current business doesn't
have much room for operating leverage The point of operating
leverages has spread the fixed costs of a business over
a large product based make more items and each item
becomes comparably cheaper to make well In this case it's
almost impossible to do that the cost of your products
come almost completely from variable expenses meaning that if you
make one wiper cost you $23 If you make two
would cost you 46 make 100 Well then it cost
you $2300 The total size of your costs change significantly
as your output changes you get no operating margin benefit
from making additional products at scale So here operating leverage
doesn't get you well pretty much anywhere Eventually you give
up the white fur thing was a bad business But
you have a new idea You're going to make luxury
air fresheners Four cars Yes you're gonna have sense like
the luv warehouse when Mona Lisa is getting cleaned or
the deck of a yacht at sunset on the Adriatic
or finding $1,000,000 check in a sock drawer that you
forgot you received Since you're targeting a luxury market you
khun set your prices relatively high Also the products themselves
has very few variable costs involved like they don't take
much labor to make They consist only of a small
bit of plastic and a spritz of smell juice Once
you get the chemical composition right for the fragrances while
the actual production is very cheap Meanwhile this time you
were able to find some investors which means you don't
have to work out of your garage You build a
factory which means you have a higher fixed cost But
it also means that you can produce the items at
scale meaning thousands of them This setup represents a perfect
situation to take advantage of operating leverage Well guess what
You sell the freshness for four bucks each they only
cost 79 cents to make a gross margin of just
over 80% The fixed costs the factory well or $2,000,000
a month You made 1,000,000 fresheners in your first month
and that's $700,000 in variable expenses plus 2,000,000 in fixed
expenses or 2.7 9,000,000 in overall operating expenses for the
month And you sold all of them 100% At four
bucks We had revenue of $4,000,000 or operating margins of
30.25% But you have a great opportunity to improve profitability
by applying some operating leverage like your factory has capacity
to make 5,000,000 units a month plenty of room to
expand production Will you double production in your second month
and you make 2,000,000 units which increases your variable expenses
Toe 1.5 8,000,000 See there's the math but you're fixed
Costs remain well fixed They still come in at $2,000,000
right Total operating expenses then 3.5 8,000,000 total revenue 8,000,000
Because you sold him all those figures mean you had
operating profit of 55.25% You increased your operating margin from
just over 32 just over 55% by doubling your production
anyway that increase represents the power of operating leverage The
more products you have to spread out your fixed expenses
upon well the less expensive each unit gets to produce
However it works best in scenarios with high gross margin
and low variable cost products So in the right scenario
operating leverage can help a profitable company become mega profitable
Maybe you should consider a new luxury fragrance of operating
leverage on the doing Morning Yeah What I'm putting in
my car
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