The assertion that an increase (decrease) in revenue directly affects the size of profit underlies the interpretation of the actions of operating leverage. The conclusion about the strength of the operating leverage is made on the basis of the formula presented as the ratio of sales proceeds minus variable costs (gross margin) to profit.
It is assumed that the amount of the margin should cover the fixed costs of the enterprise and form a profit. The level of influence of operating leverage approaches the threshold of profitability and decreases in proportion to the growth of sales revenue. A business structure, receiving financial support (loans), has the opportunity to increase production, increase profits, it is in such a logical chain that the relationship between the effect of the influence of financial and operational leverage is established.
But this happens up to a certain point: with the increase in production volumes, there is a corresponding increase in costs and a decrease in profits. There is a pattern of changes in the relationship between operating leverage and production risks. There are no uniform standards for the size of the operating lever. Its value varies depending on the industry in which the enterprise operates and certain boundaries of values are established. This is the size of production, which, firstly, corresponds to the margin of profitability, and secondly, causes a one-time increase in fixed costs.
Let's consider several examples of how to calculate operating leverage for symbolic business structures.
Example 1 The information base will serve as the initial data financial reporting: at the same time, the revenue is 650 million rubles, the cost price (total costs) is 340 million rubles, including fixed costs are 35 and variable 305 million rubles. The method is based on the formula of the operating leverage effect.
First, let's determine the amount of marginal income (revenue minus variable costs), which is the basis for determining the effect of operating leverage. In accordance with the conditions of the example, the margin will be:
650 million rubles - 305 million rubles = 345 million rubles
We will calculate the gross (operating) profit by subtracting the cost price from the proceeds, respectively, the difference will be:
650 million rubles - 340 million rubles = 310 million rubles
The strength of operating leverage will be presented as a ratio of margin to gross profit. Based on the calculated data, the value of such a coefficient will be:
345 million rubles / 310 million rubles = 1.11
The presented calculations make it possible to conclude that a 10% increase in revenue will make it possible to increase gross profit by 11.1% (10% * 1.11), a decrease in sales by 3% will lead to a decrease in operating profit by 3.34% (3 %*1.11).
Example 2 It is necessary to determine whether the activity of an enterprise that serves 150 clients (O) per month for the provision of services is profitable, fixed costs amount to 400 thousand rubles. (PZ), variable costs per client amount to 14 thousand rubles. (Per. Z). At the same time, the price of the service for the client is 20 thousand rubles. (C). According to the given parameters, the estimated amount of profit will be equal to:
Profit \u003d (P - Per. Z) * O - PZ \u003d (20-14) * 150-400 \u003d 500 (thousand rubles)
How will the amount of profit change if the growth in the number of customers per month is 20 (∆О) and the amount of costs remains at the same level?
Profit \u003d (20-14) * 170-400 \u003d 620 (thousand rubles)
It follows from the calculations that the effect of the operating leverage will be displayed as an increase in the volume of services by 13.3% ((170-150) / 150 * 100% \u003d 13.3%), with an increase in profit by 24% ((620-500) / 500 = 24%). With an increase in sales by 13.3%, profit increases by 24%, therefore, a 1% increase in revenue leads to an increase in profit by 1.8% (24/13.3).
From the above calculations, we can conclude that the production leverage, due to the fact that the cost structure includes fixed costs, reflects the ratio of the rate of change in profit and revenue.
The operating leverage effect displays the relationship between changes in revenue in relation to changes in profit. The impact of the effect palette is expressed through the disproportionate impact of semi-fixed and semi-variable costs on the results of the enterprise, taking into account changes in sales (production).
It is also true that an increase in sales leads to a decrease in semi-fixed costs, the degree of operating leverage falls. The inverse statement is the regularity that the greater the proportion of conditionally fixed costs and the cost of production, the more intense the action of the operating lever.
Due to the fact that the fixed costs of the enterprise remain stable for a relatively short time, the effect of production leverage is short-term. When changing the amount of fixed costs, it is necessary to recalculate the break-even point and conduct business in accordance with the new indicators. With such a change, the effect of production leverage takes place in new conditions in a new way.
Operating leverage (production leverage) is a potential opportunity to influence the company's profit by changing the cost structure and production volume.
The effect of operating leverage is that any change in sales revenue always leads to a larger change in profit. This effect is caused by varying degrees of influence of the dynamics of variable costs and fixed costs on the financial result when the volume of output changes. By influencing the value of not only variable, but also fixed costs, you can determine by how many percentage points the profit will increase.
The level or strength of the impact of the operating leverage (Degree operating leverage, DOL) is calculated by the formula:
DOL = MP/EBIT = ((p-v)*Q)/((p-v)*Q-FC)
MP - marginal profit;
EBIT - earnings before interest;
FC - semi-fixed production costs;
Q is the volume of production in physical terms;
p - price per unit of production;
v - variable costs per unit of output.
Marginal profit.
Marginal revenue (marginal income) is the difference between the income received from sales and variable costs. It is a source of covering fixed costs and a source of profit generation.
The level of operating leverage allows you to calculate the percentage change in profit depending on the dynamics of sales by one percentage point. In this case, the change in EBIT will be DOL%.
The greater the share of the company's fixed costs in the cost structure, the higher the level of operating leverage, and hence the greater the business (production) risk.
As revenue moves away from the break-even point, the impact of operating leverage decreases, and the organization's financial strength, on the contrary, grows. This feedback is associated with a relative decrease in the fixed costs of the enterprise.
Since many enterprises produce a wide range of products, it is more convenient to calculate the level of operating leverage using the formula:
DOL = (S-VC)/(S-VC-FC) = (EBIT+FC)/EBIT
where S - sales proceeds; VC - variable costs.
The level of operating leverage is not a constant value and depends on a certain, basic implementation value. For example, with a breakeven volume of sales, the level of operating leverage will tend to infinity. The level of operating leverage is greatest at a point just above the breakeven point. In this case, even a slight change in sales leads to a significant relative change in EBIT. The change from zero profit to any profit represents an infinite percentage increase.
In practice, those companies that have a large share of fixed assets and intangible assets (intangible assets) in the balance sheet structure and large management expenses have a large operating leverage. Conversely, the minimum level of operating leverage is inherent in companies that have a large share of variable costs.
Thus, understanding the mechanism of operation of production leverage allows you to effectively manage the ratio of fixed and variable costs in order to increase the profitability of the company's operations.
The concept of "lever" is widely used in various natural sciences and denotes a device or mechanism that allows you to increase the impact on some object. In financial management, as such a mechanism, you
there is a constant component in the total costs of the enterprise.
Under the operating leverage (OL) understand the share of fixed costs in the costs incurred by the company in the course of its core business. This indicator characterizes the dependence of the enterprise on fixed costs in the cost of production and is an important characteristic of its business risk.
The operating leverage effect is manifested in the fact that any change in sales revenue always generates a stronger change in profit.
If the share of fixed costs in the cost of goods and services is significant, the company has a high level of operating leverage, and hence business risk. For such an enterprise, even a small change in sales volume can lead to significant change arrived.
In practical calculations, to determine the strength of the impact of operating leverage, the ratio of marginal profit (the result of sales after reimbursement of variable costs) to profit before interest and taxes is used. Given the previously accepted notation, the level or strength of the impact of the operational leverage (degree of operational leverage - DOL) can be expressed as
O x(Pv) MP MP
DOL=-----^-=---=. (10.20) Qx(P-v)-FC MP-FC EBIT K )
The level of operating leverage allows you to determine the percentage change in profit depending on the change in sales by 1%. In this case, the change in EBIT will be DOL%.
It is easy to see that when FC > 0, the denominator in (10.20) is always less than the numerator, and the value of DOL > 1. Thus, a change in revenue by 1% will lead to more significant fluctuations in profit. At the break-even point, the value of the level of operating leverage will tend to infinity. With insignificant deviations of sales volume from the break-even point, there will be a significant change in the profitability of the business, decreasing as it moves away from the critical level.
Since many enterprises produce more than one type of product, it is more convenient to determine the level of operating leverage through cost indicators.
SAL-VC _ EB IT + FC SALVC - FC EBIT y ’
A number of important conclusions follow from the foregoing.
1. With the same total costs, the higher (lower) the share of fixed costs, the higher (lower) the level of operating leverage.
3. The positive impact of the lever begins to manifest itself only after the company has overcome the break-even point of its activities. Achieving break-even is rewarded with profits that rise rapidly with each additional unit sold.
4. As sales increase further and further away from the breakeven point, the effect of leverage decreases. Each subsequent percentage increase in sales leads to an increasing rate of increase in the amount of profit. Accordingly, with any decrease in sales, profits will fall more rapidly.
5. An increase in the share of fixed costs, even with a decrease in variable costs per unit of production, always leads to the need to choose a strategy aimed at increasing sales volumes.
Consider an example.
Example 10.7
In the previous period, the company had a revenue of 1400.00 units. The total variable costs amounted to 800.00 units, and fixed costs - 250.00 units. At the same time, an operating profit of 350.00 units was received. In the next period, it is planned to increase revenue by 15%. How will the planned growth in sales affect the operating profit of the enterprise, other things unchanged?
Let's determine the value of DOL for the base period. According to the original data
1400,00-800,00 1400,00-800,00-600,00 ’ "
Thus, a 1% change in sales volume while maintaining fixed costs at the same level will cause a change in operating profit of 1.714%.
Then a 15% increase in revenue should lead to an increase in operating profit by 1.714 x 15 = 25.71%. Accordingly, its value should be
EU = 350.00 x (1 + 0.2571) = 440.00 units
Let's check our assumption by constructing a forecast income statement in the form shown in Table. 10.2. The calculation results are presented in table. 10.8.
Table J.8
Income Statement Forecast (Example 10.7)
Indicator Actual
units Plan (sales growth by 15%)
Sales revenue (SAL) 1400.00 1610.00 +15.00
Variable costs (VQ 800.00 920.00 + 15.00
Fixed costs (FQ 250.00 250.00 0
Operating profit (EBIT) 350.00 440.00 +25.71
Operating leverage is a metric that helps managers choose the appropriate enterprise strategy for managing costs, profits, and business risk. Its level may change under the influence of the following factors:
Realization price;
Sales volumes;
Variable and fixed costs;
A combination of these factors.
With unfavorable market conditions leading to a decrease in sales, as well as in the early stages of the life cycle of an enterprise, when its break-even point has not yet been overcome, it is necessary to take measures to reduce fixed costs. And vice versa, with favorable market conditions and the presence of a certain margin of financial strength (BM value), the requirements for the regime of saving fixed costs can be significantly weakened. During such periods, the enterprise can significantly expand the volume of investments in new projects and assets, carry out the reconstruction and modernization of fixed assets.
When managing fixed costs, it should be borne in mind that their share largely depends on the industry specifics of the business, which determine various requirements for the capital intensity of production, labor automation, staff qualifications, etc. In addition, fixed costs are less amenable to rapid change. Therefore, enterprises in capital-intensive industries (mining or heavy industry, mechanical engineering, etc.) usually have less ability to manage operating leverage. At the same time, service enterprises can easily adjust the level of operating leverage based on a particular market situation.
Despite these limitations, management has enough ways to influence the total amount and share of fixed costs. These include:
Reduction of selling, general company and administrative expenses in case of unfavorable market conditions;
Sale of part of unused equipment and intangible assets;
Reducing the volume of consumed utilities;
Reviewing the terms of lease payments;
The use of schemes such as subcontracting, outsourcing, etc.
When managing variable costs, the main efforts
management should be aimed at saving them. Its provision before the company overcomes the break-even point leads to an increase in marginal income, which allows you to quickly overcome this point. Further, the amount of savings in variable costs will provide a direct increase in the profit of the enterprise. The main reserves for saving variable costs include:
Decrease in the number of employees of the main and auxiliary industries by increasing their productivity;
The transition from piece-rate types of wages to time-based;
Reducing stocks of raw materials, materials and finished products during periods of unfavorable market conditions;
Introduction of resource-saving technologies;
Replacement of materials with cheaper analogues without compromising product quality;
Ensuring favorable conditions for the supply of raw materials and materials for the enterprise, etc.
Correct use of the effect of operating leverage, targeted management of fixed and variable costs, timely change in their ratio under changing business conditions allows increasing the potential for generating profits of the enterprise and reducing its business risk.
Topic 18. Financial and operational leverage and their joint actions
§1. The concept and essence of leverage or leverage
The creation and operation of an enterprise is an investment process financial results for the purpose of making a profit. The asset management process aimed at increasing profits is characterized by the indicator leverage or lever. IN financial aspect- this is some factor, a slight change in which will lead to significant changes in performance indicators.
The concept of leverage is ambiguously interpreted in the literature. However, despite the multivariance, it allows you to determine optimal volume production, the structure of liabilities, calculate the effectiveness of investments and financial risks.
Exists two types of lever, which are determined by rearranging the itemization of the income statement items. Net income is the difference between revenue and costs of two types - operating and financial. They are not interchangeable, but their values can be controlled. This division of costs is very important in a market economy. The amount of net profit depends on how efficiently the resources provided to the company are used, as well as on the structure of sources. The first point is reflected in the relationship between the main and working capital. An increase in the share of fixed assets is associated with an increase in fixed costs and, at least in theory, with a decrease in variable costs. The ratio of fixed and variable costs in the cost associated with the strategy of the enterprise and its technological policy.
The relationship between variable and fixed costs is non-linear and is estimated operational(production) lever.
Operating lever– potential opportunity to influence gross profit by changing the cost structure.
The level of operating leverage is usually measured by the ratio of the growth rate of profit before taxes and interest to the growth rate of revenue or physical volume:
Y op \u003d DOL \u003d T p EBIT / T p BP,
Uop - level of operating leverage;
EBIT - earnings before taxes and interest;
VR - sales proceeds;
T r EBIT - the growth rate of profit before taxes and interest;
T r BP - the growth rate of sales proceeds.
The level of operating leverage shows the degree of sensitivity of gross profit to changes in production volumes. When it high values even small changes in production volumes will lead to a significant change in gross profit. Enterprises with a high share of the technological component have enough high level operating lever.
Sales revenue is calculated by the formula:
Q is the physical volume of production;
P is the unit price of the product.
Profit before taxes and interest is calculated by the formula:
EBIT = Q * P - (Q * V + F) = Q * (P - V) - F,
V - variable costs per unit of production;
F - fixed costs.
Assume that the volume of production increased by 1%. Then:
EBIT = 1.01 * Q * (P - V) - F,
The absolute change in profit is:
ΔEBIT = 1.01 * Q * (P - V) - F - Q * (P - V) + F = 0.01 * Q * (P - V)
Let's find the growth rate:
T pr EBIT \u003d 0.01 * Q * (P - V) / * 100% \u003d Q * (P - V) / \u003d (EBIT + F) / EBIT \u003d MD / P r,
MD - marginal income;
P r - profit.
It can be seen from the formula that if an enterprise has fixed costs are equal to zero, then the force of the operating lever is equal to 1.
Example. The company's management intends to increase sales revenue by 10% from 40 to 44 thousand rubles. Total variable costs amounted to 31 thousand rubles, fixed costs - 3 thousand rubles. Calculate the amount of profit corresponding to the new level of revenue in the traditional way and using operating leverage.
V 1 \u003d 31 + 31 * 0.1 \u003d 34.1 thousand rubles.
P p 1 \u003d 44 - 34.1 - 3 \u003d 6.9 thousand rubles.
Profit calculation with operating leverage:
P p 0 \u003d 40 - 31 - 3 \u003d 6 thousand rubles.
MD 0 \u003d 40 - 31 \u003d 9 thousand rubles.
SVPR \u003d MD / P p \u003d 9 / 6 \u003d 1.5,
where SVPR is the force of the production leverage.
If revenue increases by 10% with an operating leverage of 1.5, then profit growth will be 15%:
T pr Pr \u003d 10% * 1.5 \u003d 15%
P p 1 \u003d 6 + 6 * 0.15 \u003d 6.9 thousand rubles.
Fomina Irina Alexandrovna
professor of St. Petersburg state university civil aviation,
Candidate of Economic Sciences, Associate Professor 196210, St. Petersburg, st. Pilotov, 38
Pie Anna Igorevna
Vorontsova Alexandra Mikhailovna
postgraduate student of St. Petersburg State University
civil aviation 196210, St. Petersburg, st. Pilotov, 38
ECONOMICS AND MANAGEMENT
N 3 (65) 201
The article deals with the issues of management accounting in order to improve the activities of the enterprise. The authors come to the conclusion that in order to solve this problem and more effective management profit, it is necessary to calculate the final performance indicators of the enterprise on the basis of the marginal approach, which is demonstrated by the example of UTair airline.
The marginal approach is an integral part of managerial decision-making at enterprises various areas activities.
Comprehensive performance assessment economic activity characterizes the level and dynamics of the final performance indicators of the enterprise.
In accordance with the purpose of any commercial activity, such totals are sales revenue and profit.
Marginal analysis (break-even analysis) is widely used in countries with developed market relations. It allows you to study the dependence of profit on a small circle of the most important factors and on the basis of this to control the process of formation of its value.
The main features of marginal analysis are to determine:
break-even sales volume (profitability threshold, cost recovery) at given price ratios, fixed and variable costs;
security zones (break-even) of the enterprise;
the required volume of sales to obtain a given amount of profit;
critical level of fixed costs at a given level of marginal income;
critical selling price for a given sales volume and the level of variable and fixed costs.
With the help of marginal analysis, other management decisions: select change options production capacity, equipment options, production technology, purchase of components, evaluation of the effectiveness of accepting an additional order, product range, prices for a new product, etc.
IN modern conditions on Russian enterprises issues of mass regulation and profit dynamics come to one of the first places in management financial resources. The solution of these issues is included in the scope of operational (production) financial management.
The basis of financial management is financial economic analysis, during which the analysis of the cost structure is of paramount importance.
It is known that entrepreneurial activity associated with many factors influencing its result, which are usually divided into two groups. The first group of factors is associated with profit maximization through pricing policy, profitability of products, its competitiveness. The second group of factors is associated with the identification of critical indicators in terms of the volume of products sold, the best combination marginal revenue and marginal cost, with the division of costs into variable and fixed.
Analysis of production costs allows you to determine their impact on the amount of profit from sales, but if you go deeper into these problems, it turns out the following.
This division:
helps to solve the problem of increasing the mass of profits due to the relative reduction of certain costs;
allows you to search optimal combination variable and fixed costs, providing an increase in profits;
allows you to judge the cost recovery and financial stability in case of deterioration of the economic situation.
The following indicators can serve as a criterion for choosing the most profitable products:
gross margin per unit of production;
the share of gross margin in the price of a unit of production;
gross margin per unit of limited factor.
Considering the behavior of variable and fixed costs, one should analyze the composition and structure of costs per unit of output in a certain period of time and with a certain number of sales. The behavior of variable and fixed costs when the volume of production changes is characterized as follows (Table 1).
Table 1. The behavior of fixed and variable costs with a change in the volume of production
The cost structure is not so much a quantitative relationship as a qualitative one. Nevertheless, the impact of the dynamics of variable and fixed costs on the formation of financial results with a change in production volume is very significant. The concept of operating leverage is closely related to the cost structure.
An analysis of the dynamics of sales proceeds and profits of enterprises shows that a change in sales proceeds causes a stronger change in profit. This effect is called production (operational) leverage.
A number of indicators are used to calculate the effect, or force, of leverage. This requires the division of costs into variable and fixed using intermediate result. This value is usually called the gross margin (coverage amount, contribution).
These metrics include:
gross margin = profit from sales + fixed costs;
contribution (coverage amount) = sales proceeds - variable costs;
the strength of the impact of the operating lever = (sales proceeds - variable costs) / profit from sales;
operating leverage effect = profit growth rate/revenue growth rate.
If we interpret the effect of the operating leverage as a change in the gross margin, then its calculation will allow us to answer the question of how much the profit changes from an increase in the volume (production, sales) of products.
There is a direct relationship between the value of the production (operating lever) and the ratio of fixed and variable costs:
1) the value of the leverage is greater, the higher the level of the ratio of fixed costs to variables;
2) the value of the leverage is the smaller, the lower the level of the ratio of fixed costs to variables. The calculation of the effect of operating leverage in the system of marginal analysis of UTair's activities is presented in Table. 2.
Table 2. Calculation of the threshold of profitability, margin of financial strength, the strength of the impact of the operating leverage of UTair airline
| Indicators | Unit | Year | ||
| 2008 | 2007 | 2006 | ||
| Total revenue | Thousand rub. | 16 974 418 | 12 110 492 | 8 320 060 |
| Costs are variable | Thousand rub. | 10 211334 | 7 432 199 | 4 508 407 |
| Gross Margin (B - VC) | Thousand rub. | 6 763 084 | 4 678 293 | 3 811653 |
| Gross margin ratio (VM/V) | 0,4 | 0,37 | 0,5 | |
| Profitability Threshold (FC/KBM) | Thousand rub. | 9 293 071 | 8 697 659 | 6 257 244 |
| ZFP (V - PR) | Thousand rub. | 7 681 347 | 3 412 833 | 2 062 816 |
| Profit (ZFP KVM) | Thousand rub. | 3 060 464 | 1 318 380 | 945 034 |
| Impact force 0R | 2,2 | 3,5 | 4,0 | |
| Profitability of sales (P/V 100%) | % | 18,0 | 10,9 | 5,6 |
| Profitability of production (P/R 100%) | % | 29,9 | 17,7 | 20,9 |
Source: the table was compiled based on the author's calculations based on data from the UTair Aviation website: www.utair.ru. Note: B - proceeds from the sale of aviation services; VC - variable costs; FC - fixed costs; VM - gross margin; KVM - gross margin ratio; ZFP - margin of financial strength; PR - profitability threshold; OR - operating lever; P - operating profit; R - operating costs.
Analysis of the data obtained shows that the company's revenue is above the threshold of profitability. In turn, this indicates that the profitability threshold was overcome for all analyzed periods and the airline is in the profit zone, i.e., it receives profit from its main activities.
It can also be seen that the gross margin provides coverage of fixed costs and forms the profit of the enterprise both in 2008 and in 2007 and 2006.
The margin of financial strength shows that even if the airline had a drop in revenue by 7,681,347 thousand. rub. [Ibid.], then the UTair group could have endured this before suffering losses. It is similar for 2007 and 2006. It can be seen that in 2006 the margin of financial safety, although it existed, was insignificant, which indicated a warning about the danger. However, by 2008, the so-called "safety cushion" was formed - due to an increase in the margin of financial strength. It is reasonable to say that the degree of risk is getting lower every year.
According to the results of the operating leverage indicator, it can be judged that the sales revenue is increasing, therefore, the impact of the operating leverage is decreasing. Each percentage increase in revenue results in less and less operating leverage. Based on the foregoing, it can be concluded that the degree of entrepreneurial risk is decreasing, since the strength of the impact of the operating lever decreases every year.
Thus, based on the performed marginal analysis, we can speak about the successful operation of UTair Aviation in the air transportation market.
There are other, more complex, modifications of the formula for calculating the effect of operating leverage, which differ from the one presented by us. However, despite the differences in the algorithms for determining the effect of operating leverage, the content of the operating profit management mechanism by influencing the ratio of fixed and variable costs of an enterprise remains unchanged.
In specific situations of the operating activity of the enterprise, the manifestation of the operating leverage mechanism has a number of features that must be taken into account in the process of its use for profit management. Let's formulate the main ones.
1. The positive impact of operating leverage begins to manifest itself only after the company has overcome the break-even point of its operating activities.
2. After breaking the break-even point - the higher the operating leverage ratio, the greater the impact on profit growth will be the company, increasing the volume of sales.
3. The greatest positive impact of operational leverage is achieved in the field as close as possible to the break-even point (after it has been overcome).
4. The mechanism of operating leverage also has the opposite direction - with any decrease in the volume of sales of products, the size of gross operating profit will decrease even more.
5. The effect of operating leverage is stable only in the short run.
This is determined by the fact that operating costs, which are classified as fixed, remain unchanged only for a short period of time. As soon as in the process of increasing the volume of sales of products there is another jump in the amount of fixed operating costs, the company needs to overcome a new break-even point or adapt its operating activities to it. In other words, after such a jump, which causes a change in the operating leverage ratio, its effect manifests itself in a new way in the new business conditions.
Understanding the mechanism of manifestation of operating leverage allows you to purposefully manage the ratio of fixed and variable costs in order to increase the efficiency of operating activities. This control comes down to changing the value of the operating leverage ratio for various commodity market trends and stages life cycle enterprises.
In case of unfavorable commodity market conditions, which determine a possible decrease in the volume of sales of products, as well as in the early stages of the life cycle of an enterprise, when it has not yet overcome the break-even point, it is necessary to take measures to reduce the value of the operating leverage ratio. And vice versa, if the commodity market is favorable and there is a certain margin of safety (margin of safety), the requirements for the implementation of the fixed cost savings regime can be significantly weakened - during such periods, the enterprise can significantly expand the volume of real investments by reconstructing and modernizing production fixed assets.
Operating leverage can be managed by influencing both fixed and variable operating costs.
When managing fixed costs, it should be borne in mind that their high level is largely determined by the industry specifics of the implementation of operating activities, which determine different level capital intensity of manufactured products, differentiation of the level of mechanization and automation of labor.
It should be noted that fixed costs are less amenable to rapid change, so enterprises with high ratio operating leverage, lose flexibility in managing their costs. Despite these objective limitations, if necessary, each enterprise has enough opportunities to reduce the amount and specific gravity fixed operating costs.
Such reserves include a significant reduction in overhead costs (management costs) in case of unfavorable commodity market conditions; sale of part of unused equipment and intangible assets in order to reduce the flow of depreciation charges; widespread use of short-term forms of leasing machinery and equipment instead of acquiring them as property; reduction in the volume of a number of consumed utilities and some others.
When managing variable costs, the main guideline should be to ensure their constant savings, since there is a direct relationship between the amount of these costs and the volume of production and sales of products. Providing these savings before the company overcomes the break-even point leads to an increase in the amount of marginal profit, which allows you to overcome this point faster.
After breaking the break-even point, the amount of savings in variable costs will provide a direct increase in gross operating profit. The main reserves for saving variable costs include:
reduction in the number of employees of the main and auxiliary industries by ensuring the growth of their labor productivity;
reduction of stocks of raw materials, materials, finished products during periods of unfavorable commodity market conditions;
provision of favorable conditions for the supply of raw materials and materials for the enterprise, and others. Purposeful management of fixed and variable costs, prompt change in their ratio under changing business conditions can increase the potential for the formation of the operating profit of the enterprise.
Operating leverage is an indicator that answers the question of how many times the rate of change in sales profit exceeds the rate of change in sales revenue. In other words, when planning an increase or decrease in sales revenue, using the operating leverage indicator allows you to simultaneously determine the increase or decrease in profit. Conversely, if in the planning period the company needs a certain amount of profit from sales, using the operating lever, you can determine what sales revenue will provide the desired profit.
The mechanism for applying operating leverage depends on what factors affect the change in sales revenue in the planning period compared to the base period: price dynamics, or dynamics of natural sales volume, or both factors together.
As a rule, in practice, revenue increases or decreases under the influence of the simultaneous action of both factors. But when planning profit essential have the degree and direction of impact on the revenue of each factor.
The dynamics of sales proceeds as a result of a decrease or increase in prices for sold products (works, services) affects the amount of profit differently than the dynamics of proceeds as a result of an increase or decrease in the natural volume of sales.
If the change in demand for products is expressed only through price changes, and the natural volume of sales remains at the basic level, then the entire amount of the increase or decrease in sales proceeds simultaneously becomes the amount of increase or decrease in profit.
If the basic prices are maintained, but the natural volume of sales changes, then the increase or decrease in profit is the sum of the increase or decrease in revenue, reduced by the corresponding change in the value of variable costs.
Consequently, the change in prices is more reflected in the dynamics of profit from sales than the change in the natural volume of sales. It has already been said that the operating lever is a measure of the excess of the rate of profit dynamics over the rate of revenue dynamics.
Thus, even without making any calculations, we can state the following: the indicator of operating leverage with a change in revenue only due to prices will always be higher than with a change in revenue only due to the natural volume of sales.
Based on the foregoing, it can be concluded that it is expedient to use the marginal approach when calculating the final performance indicators of an airline in order to make informed management decisions.
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The ratio of costs for a given volume of sales, one of the options for measuring which is the ratio of marginal income to profit, is called operating leverage. This indicator is "quantified by the ratio between fixed and variable costs in their total amount and the variability of the indicator" profit before interest and taxes ". It is higher in those companies in which the ratio of fixed costs to variables is higher, and accordingly lower in the opposite case.
The indicator of the operating lever allows you to quickly enough (without preparation full report income statement) to determine how changes in sales volume will affect the company's profit. Multiply the percentage change in sales by the level of operating leverage to determine the percentage change in profit.
One of the main tasks of the analysis of the ratio "costs - volume - profit" is the selection of the most profitable combinations of variable and fixed costs, sales prices and sales volumes. The value of marginal income (both gross and specific) and the value of the marginal income ratio are key in making decisions related to the costs and income of companies. Moreover, the adoption of these decisions does not require the preparation of a new income statement, since only an analysis of the growth of those items that are supposed to be changed can be used.
When using the analysis, you should be clear about the following:
First, a change in fixed costs changes the position of the break-even point, but does not change the size of marginal income.
Secondly, a change in variable costs per unit of output changes the value of the marginal income indicator and the location of the break-even point.
Thirdly, the simultaneous change in fixed and variable costs in the same direction causes a strong shift in the break-even point.
Fourth, a change in the selling price changes the margin and the location of the break-even point.
IN practical calculations to determine the strength of the impact of operating leverage, the ratio of gross margin to profit is used:
Operating leverage measures the percentage change in earnings for a one percent change in revenue. Thus, by setting a certain rate of growth in the volume of sales (revenue), it is possible to determine the extent to which the amount of profit will increase with the strength of the operating leverage prevailing at the enterprise. Differences in the effect achieved at different enterprises will be determined by differences in the ratio of fixed and variable costs.
Understanding the mechanism of operation of the operating lever allows you to purposefully manage the ratio of fixed and variable costs in order to improve the efficiency of the current activities of the enterprise. This management is reduced to changing the value of the strength of the operating lever for various trends in the conjuncture of the commodity market and stages of the life cycle of the enterprise.
With unfavorable commodity market conditions, as well as in the early stages of the life cycle of an enterprise, its policy should be aimed at reducing the strength of the operating lever by saving on fixed costs. With favorable market conditions and with a certain margin of safety, the requirement for the implementation of a fixed cost savings regime can be significantly weakened. During such periods, an enterprise can expand the volume of real investments by modernizing fixed production assets. It should be noted that fixed costs are less amenable to rapid change, so enterprises with greater operating leverage lose flexibility in managing their costs. As for variable costs, the basic principle of managing variable costs is to ensure their constant savings.
The margin of financial strength is the edge of the enterprise's safety. The calculation of this indicator allows us to assess the possibility of an additional reduction in revenue from sales of products within the break-even point. Therefore, the financial safety margin is nothing more than the difference between the sales proceeds and the profitability threshold. The margin of financial strength is measured either in monetary terms or as a percentage of the proceeds from product sales:
So, the strength of the operating lever depends on the share of fixed costs in their total amount and determines the degree of flexibility of the enterprise. All this taken together generates entrepreneurial risk.
One of the factors that “weight” fixed costs is the increase in the effect of “financial leverage” with an increase in interest on a loan in the capital structure. In turn, operating leverage generates stronger earnings growth than sales volume (revenue) growth, increasing earnings per share and thereby strengthening financial leverage. Thus, financial and operational levers are closely linked, mutually reinforcing each other.
The combined effect of operating and financial leverage is measured by the level of the conjugate effect of both levers, which is calculated using the following formula:
The level of the conjugated effect of the action of both levers indicates the level of the total risk of the enterprise and shows the percentage change in earnings per share when the volume of sales (sales proceeds) changes by 1%.
The combination of strong operating leverage with strong financial leverage can be detrimental to an enterprise, as entrepreneurial and financial risks multiply, multiplying adverse effects. The interaction of operational and financial leverage exacerbates negative impact declining revenue by the amount of net profit.
The task of reducing the overall risk of the enterprise is reduced to choosing one of three options:
1. High level of financial leverage combined with weak operating leverage.
2. Low level of financial leverage combined with strong operating leverage.
3. Moderate levels of financial and operational leverage effects, which is the most difficult to achieve.
In the very general view The criterion for choosing one or another option is the maximum possible market value of the company's shares with minimal risk. As you know, this is achieved through a compromise between risk and return.
The level of conjugated effect of operating and financial leverage allows making planned calculations of the future value of earnings per share depending on the planned volume of sales (revenue), which means the possibility of direct access to the company's dividend policy.
Control questions
2. The mechanism of enterprise cost management.
3. Analysis of the influence of factors on the total cost.
4. The essence of the concept of "margin income"
5. The concept of "breakeven point", "margin of safety", "operating leverage", "financial leverage".
In Russian accounting practice, the terms "operating leverage" and "production leverage (lever)" are also used.