The effect of operating leverage is reduced.  Financial analysis and investment evaluation of the enterprise

The concept of operating leverage is closely related to the cost structure of a company. Operating lever or production leverage(leverage - leverage) is a mechanism for managing the company's profit, based on improving the ratio of constants and variable costs.

With its help, you can plan a change in the organization's profit depending on the change in the volume of sales, as well as determine the break-even point. A necessary condition for the application of the mechanism of operating leverage is the use of a marginal method based on the division of costs into fixed and variable. The lower the share of fixed costs in the total cost of the enterprise, the more the amount of profit changes in relation to the rate of change in the company's revenue.

As we know, there are two types of costs in the enterprise: variables and constants. Their structure as a whole, and in particular the level of fixed costs, in the total revenue of an enterprise or in revenue per unit of production can significantly affect the trend in profits or costs. This is due to the fact that each additional unit of production brings some additional profitability, which goes to cover fixed costs, and depending on the ratio of fixed and variable costs in the company's cost structure, the total increase in revenue from an additional unit of goods can be expressed in a significant sharp change in profit. As soon as the break-even point is reached, there is profit, which begins to grow faster than sales.

The operating lever is a tool for defining and analyzing this dependence. In other words, it is designed to establish the impact of profit on the change in sales volume. The essence of its action lies in the fact that with the growth of revenue there is a higher growth rate of profit, but this higher growth rate is limited by the ratio of fixed and variable costs. The lower the proportion of fixed costs, the lower this constraint will be.

Production (operational) leverage is quantitatively characterized by the ratio between fixed and variable costs in their total amount and the value of the indicator "Profit before interest and taxes". Knowing the production lever, it is possible to predict the change in profit with a change in revenue. Distinguish price and natural price leverage.

Price operating (production) leverage

The price operating leverage (Рц) is calculated by the formula:

Rts = V / P

Where,
B - sales revenue;
P - profit from sales.

Given that V \u003d P + Zper + Zpost, the formula for calculating the price operating leverage can be written as:

Rts \u003d (P + Zper + Zpost) / P \u003d 1 + Zper / P + Zpost / P

Where,
Zper - variable costs;
Zpost - fixed costs.

Natural operating (production) leverage

Natural operating leverage (Рн) is calculated by the formula:

Rn \u003d (V-Zper) / P \u003d (P + Zpost) / P \u003d 1 + Zpost / P Where,
B - sales revenue;
P - profit from sales;
Zper - variable costs;
Zpost - fixed costs.

Operating leverage is not measured as a percentage, as it is the ratio of marginal income to profit from sales. And since the marginal income, in addition to the profit from sales, also contains the amount of fixed costs, the operating leverage is always greater than one.

the value operating leverage can be considered an indicator of the riskiness of not only the enterprise itself, but also the type of business in which this enterprise is engaged, since the ratio of fixed and variable costs in overall structure costs is a reflection not only of the characteristics of the enterprise and its accounting policy, but also industry specifics of activity.

However, it is impossible to consider that a high share of fixed costs in the cost structure of an enterprise is a negative factor, as well as to absolutize the value of marginal income. An increase in production leverage may indicate an increase in the production capacity of the enterprise, technical re-equipment, and an increase in labor productivity. The profit of an enterprise with a higher level of production leverage is more sensitive to changes in revenue. With a sharp drop in sales, such an enterprise can very quickly "fall" below the breakeven level. In other words, an enterprise with a higher level of production leverage is more risky.

Since operating leverage shows the dynamics of operating profit in response to changes in the company's revenue, and financial leverage characterizes the change in profit before tax after paying interest on loans and borrowings in response to changes in operating profit, the total leverage gives an idea of ​​how much percentage change in profit before taxes after payment of interest with a change in revenue by 1%.

Thus, small operating lever can be strengthened by attracting borrowed capital. High operating leverage, on the other hand, can be offset by low financial leverage. With the help of these effective tools - operational and financial leverage- the enterprise can achieve the desired return on invested capital with a controlled level of risk.

In conclusion, we list the tasks that are solved with the help of operating leverage (production leverage):

calculation of the financial result for the organization as a whole, as well as for types of products, works or services based on the “costs - volume - profit” scheme;

determination of the critical point of production and its use in the adoption management decisions and setting prices for works;

making decisions on additional orders (the answer to the question: will an additional order lead to an increase in fixed costs?);

making a decision to stop the production of goods or the provision of services (if the price falls below the level of variable costs);

solving the problem of profit maximization due to the relative reduction of fixed costs;

using the threshold of profitability in the development of production programs, setting prices for goods, works or services.

• Gurfova Svetlana Adalbievna, Candidate of Sciences, Associate Professor, Associate Professor
• Kabardino-Balkarian State Agrarian University named after V.I. V.M. Kokova

• OPERATING LEVER POWER
• OPERATING LEVER
• VARIABLE COSTS
• OPERATIONAL ANALYSIS
• FIXED COSTS

The ratio "Volume - Costs - Profit" allows you to quantify changes in profit depending on sales volume based on the mechanism of operating leverage. The operation of this mechanism is based on the fact that profit always changes faster than any change in the volume of production, due to the presence of fixed costs as part of operating costs. In the article, using the example of an industrial enterprise, the magnitude of the operating leverage and the strength of its impact are calculated and analyzed.

• Characteristics of approaches to the definition of the concept of "financial support of the organization"
• Financial and economic state of Kabarda and Balkaria in the post-war period
• Features of the nationalization of industrial and commercial enterprises in Kabardino-Balkaria
• Influence of the sustainability of agricultural formations on the development of rural areas

One of the most effective methods of financial analysis for the purpose of prompt and strategic planning is an operational analysis, which characterizes the relationship of financial performance with costs, production volumes and prices. It helps to identify the optimal proportions between variable and fixed costs, price and sales volume, minimizing entrepreneurial risk. Operational analysis, being an integral part of management accounting, helps the financiers of the enterprise to get answers to many critical issues that arise before them at almost all the main stages of the organization's cash flow. Its results may constitute a trade secret of the enterprise.

The main elements of operational analysis are:

• operating lever (leverage);
• profitability threshold;
• stock of financial strength of the enterprise.

Operating leverage is defined as the ratio of the rate of change in sales profit to the rate of change in sales revenue. It is measured in times, shows how many times the numerator is greater than the denominator, that is, it answers the question of how many times the rate of change in profit exceeds the rate of change in revenue.

Let's calculate the amount of operating leverage based on the data of the analyzed enterprise - JSC "NZVA" (Table 1).

Table 1. Calculation of the operating leverage at OJSC NZVA

Calculations show that in 2013. the rate of change in profit was approximately 3.2 times higher than the rate of change in revenue. In fact, both revenue and profit changed upwards: revenue - by 1.24 times, and profit - by 2.62 times compared to the level of 2012. At the same time, 1.24< 2,62 в 2,1 раза. В 2014г. прибыль уменьшилась на 8,3%, темп ее изменения (снижения) значительно меньше темпа изменения выручки, который тоже невелик – всего 0,02.

For each specific enterprise and each specific planning period, there is its own level of operating leverage.

When a financial manager pursues the goal of maximizing the rate of profit growth, he can influence not only variable costs, but also fixed costs by applying increment or decrement procedures. Depending on this, he calculates how the profit has changed - increased or decreased - and the magnitude of this change as a percentage. In practice, to determine the strength of operating leverage, a ratio is used in which the numerator is sales revenue minus variable costs (gross margin), and the denominator is profit. This figure is often referred to as the coverage amount. It is necessary to strive to ensure that the gross margin covers not only fixed costs, but also forms a profit from sales.

To assess the impact of a change in sales revenue on profit, expressed as a percentage, the percentage of revenue growth is multiplied by the strength of the impact of operating leverage (COR). Let's determine the SVOR at the assessed enterprise. The results are presented in the form of table 2.

Table 2. Calculation of the force of the impact of the operating lever on JSC "NZVA"

As shown in Table 2, the amount of variable costs for the analyzed period increased steadily. Yes, in 2013. it amounted to 138.9 percent compared to the level of 2012, and in 2014. - 124.2% compared to the level of 2013. and 172.5% to the level of 2012. The share of variable costs in the total costs for the analyzed period is also steadily increasing. Share of variable costs in 2013 increased compared to 2012. from 48.3% to 56%, and in 2014. - another 9 percentage points compared to the previous year. The force with which the operating lever acts steadily decreases. In 2014 it decreased by more than 2 times compared with the beginning of the analyzed period.

From the point of view of the financial management of the organization's activities, net profit is a value dependent on the level rational use financial resources of the enterprise, i.e. the direction of investment of these resources and the structure of sources of funds are very important. In this regard, the volume and composition of fixed and working capital, as well as the effectiveness of their use, are being studied. Therefore, the change in the level of strength of the operating leverage was also influenced by the change in the structure of the assets of NZVA OJSC. In 2012 the share of non-current assets in the total assets amounted to 76.5%, and in 2013. it increased to 92%. The share of fixed assets accounted for 74.2% and 75.2%, respectively. In 2014 the share of non-current assets decreased (to 89.7%), but the share of fixed assets increased to 88.7%.

Obviously, the greater the proportion of fixed costs in total costs, the more greater strength the production lever operates and vice versa. This is true when sales revenue increases. And if sales revenue decreases, then the force of production leverage, regardless of the share of fixed costs, increases even faster.

Thus, we can conclude that:

• the structure of the organization's assets, the share of non-current assets, has a significant impact on the SVOR. With the growth of the cost of fixed assets, the proportion of fixed costs increases;
• a high proportion of fixed costs limits the ability to increase the flexibility of current cost management;
• with the increase in the force of the impact of the production lever, the entrepreneurial risk increases.

The SVOP formula helps answer the question of how sensitive the gross margin is. Later, by progressively transforming this formula, we will be able to determine the strength with which operating leverage operates, based on the price and magnitude of variable costs per unit of goods, and the total amount of fixed costs.

The strength of the impact of the operating leverage, as a rule, is calculated for a known volume of sales, for a given specific sales proceeds. With a change in sales revenue, the strength of the impact of operating leverage also changes. SIDS is largely determined by the influence of the average industry level of capital intensity as an objective factor: with the growth in the cost of fixed assets, fixed costs increase.

However, the effect of production leverage can still be controlled using the dependence of the SVOP on the amount of fixed costs: with an increase in fixed costs and a decrease in profits, the effect of the operating lever increases, and vice versa. This can be seen from the transformed formula for the force of the operating lever:

VM / P \u003d (Z post + P) / P, (1)

Where VM– gross margin; P- profit; Z post- fixed costs.

The strength of operating leverage increases with an increase in the share of fixed costs in the gross margin. At the analyzed enterprise in 2013. the share of fixed costs decreased (since the share of variable costs increased) by 7.7%. Operating leverage decreased from 17.09 to 7.23. In 2014 - the share of fixed costs decreased (with an increase in the share of variable costs) by another 11%. Operating leverage also decreased from 7.23 to 6.21.

With a decrease in sales revenue, an increase in SVOR occurs. Each percentage decrease in revenue causes an increasing decrease in profits. This reflects the strength of the operating leverage.

If, on the other hand, sales revenue increases, but the break-even point has already been passed, then the operating leverage decreases, and faster and faster with each percentage increase in revenue. At a small distance from the threshold of profitability, the SRR will be maximum, then it will again begin to decrease until the next jump in fixed costs with the passage of a new point of cost recovery.

All these points can be used in the process of forecasting income tax payments in the course of optimizing tax planning, as well as in developing detailed components of the company's commercial policy. If the expected dynamics of sales revenue is sufficiently pessimistic, then it is impossible to increase fixed costs, since the decrease in profit from each percentage decrease in sales revenue can become several times greater as a result of the cumulative effect caused by the influence of a large force of operating leverage. However, if an organization assumes an increase in demand for its goods (works, services) in the long term, then it can afford not to save heavily on fixed costs, since a large share of them is quite capable of providing a higher increase in profits.

In circumstances that contribute to a decrease in the income of the enterprise, it is very difficult to reduce fixed costs. In other words, a high proportion of fixed costs in their total amount indicates that the enterprise has become less flexible, and, therefore, more weakened. Organizations often feel the need to move from one area of ​​activity to another. Of course, the possibility of diversification is at the same time a tempting idea, but also very difficult in terms of organization, and especially in terms of finding financial resources. The higher the cost of tangible fixed assets, the more reasons the company has to stay in its current market niche.

In addition, the state of the enterprise with a high share of fixed costs significantly increases the effect of operating leverage. In such conditions, a decrease in business activity means for the organization a multiplied loss of profit. However, if the revenue grows at a sufficiently high rate, and the company has a strong operating leverage, then it will be able not only to pay the necessary amounts of income tax, but also to ensure good dividends and proper financing of its development.

SVOR indicates the degree of entrepreneurial risk associated with a given business entity: the greater it is, the higher the entrepreneurial risk.

In the presence of a favorable market situation, an enterprise characterized by a greater strength of the operating leverage (high capital intensity) receives an additional financial gain. However, capital intensity should be increased only in the case when an increase in the volume of sales of products is really expected, i.e. with great care.

Thus, by changing the growth rate of sales volume, it is possible to determine how the amount of profit will change with the force of operating leverage that has developed at the enterprise. The effects achieved at enterprises will vary depending on variations in the ratio of fixed and variable costs.

We have considered the mechanism of operation of the operating lever. Its understanding allows for purposeful management of the ratio of fixed and variable costs and, as a result, to improve the efficiency of the current activities of the enterprise, which actually involves the use of changes in the value of the strength of the operating lever under various trends in the commodity market and different stages of the cycle of functioning of an economic entity.

When the commodity market conditions are not favorable, and the company is early stages life cycle, in its policy it is necessary to identify possible measures that will help reduce the strength of operating leverage by saving fixed costs. With favorable market conditions and when the enterprise is characterized by a certain margin of safety, the work on saving fixed costs can be significantly weakened. During such periods, the enterprise may be recommended to expand the volume of real investments on the basis of the comprehensive modernization of fixed production assets. Fixed costs are much more difficult to change, so businesses with great power operating leverage are no longer flexible enough, which negatively affects the effectiveness of the cost management process.

The SIDS, as already noted, is significantly affected by the relative value of fixed costs. For enterprises with heavy fixed assets, high values ​​of the operating leverage indicator are very dangerous. In the process of an unstable economy, when customers are characterized by low effective demand, when the strongest inflation takes place, every percent reduction in sales revenue entails a catastrophic, wide-ranging drop in profits. The company is in the loss zone. Management seems to be blocked, that is, the financial manager cannot use most of the options for choosing the most effective and productive managerial and financial decisions.

The introduction of automated systems relatively weighs down fixed costs in the unit cost of production. Indicators react differently to this circumstance: gross margin ratio, profitability threshold and other elements of operational analysis. Automation, with all its advantages, contributes to the growth of entrepreneurial risk. And the reason for this is the tilt of the cost structure towards fixed costs. When an enterprise implements automation, it should carefully weigh its investment decisions. It is necessary to have a well-thought-out long-term strategy for the organization's activities. Automated production, having, as a rule, relatively low level variable costs, increases the operating leverage as a measure of the involvement of fixed costs. And because of the higher profitability threshold, the margin of financial safety is usually lower. That's why general level The risk associated with production and economic activities is higher with the intensification of capital than with the intensification of direct labor.

However, automated manufacturing offers more opportunities to effectively manage the cost structure than when using predominantly manual labor workers. If there is a wide choice, the business entity must independently determine what is more profitable to have: high variable costs and low fixed costs, or vice versa. It is not possible to unequivocally answer this question, since any option is characterized by both advantages and disadvantages. The final choice will depend on the initial position of the analyzed enterprise, what financial goals it intends to achieve, what are the circumstances and features of its functioning.

Bibliography

1. Blank, I.A. Encyclopedia of financial manager. T.2. Management of assets and capital of the enterprise / I.A. Form. - M .: Publishing house "Omega-L", 2008. - 448 p.
2. Gurfova, S.A. - 2015. - V. 1. - No. 39. - P. 179-183.
3. Kozlovsky, V.A. Production and operational management / V.A. Kozlovsky, T.V. Markina, V.M. Makarov. - St. Petersburg: Special Literature, 1998. - 336 p.
4. Lebedev, V. G. Cost management at the enterprise / V. G. Lebedev, T. G. Drozdova, V. P. Kustarev. - St. Petersburg: Peter, 2012. - 592 p.

Plan

Introduction

1 Essence, concept and methods of calculating operational leverage in financial management

1.1 The concept of operating leverage

1.2 The effect of operating leverage. Essence and methods for calculating the impact force of operational analysis

1.3 Three components of operating leverage

2 Using the operating lever

Conclusion

Bibliography

Introduction

One of the most important tasks of an enterprise is to assess its financial position, which is possible with a combination of methods that allow determining the state of affairs of an enterprise as a result of analyzing its activities over a finite time interval. The purpose of this analysis is to obtain information about its financial position, solvency and profitability.

Operational analysis, which tracks the dependence of the company's financial results on production (sales) volumes, is an effective method for operational and strategic planning. The task of operational analysis is to find the most profitable combination of variable and fixed costs, price and sales volume. The key elements of operational analysis are the gross margin, operating and financial leverage, profit margin, and the firm's margin of safety.

In conditions market economy the well-being of any enterprise depends on the amount of profit received. One of the tools for managing and influencing the balance sheet profit of an enterprise is operating leverage (lever). It allows you to evaluate the economic benefits as a result of changes in the cost structure and output volume. Analysts use operating leverage to determine how sensitive a company's operating profit is to changes in sales volume. This indicator is closely related to the calculation of the break-even area, i.e. points with zero operating profit (total revenues equal to total costs).

IN general view operating production leverage (leverage) is a process of managing the assets and liabilities of an enterprise, aimed at increasing profits, i.e. this is a certain factor, a small change of which can lead to a significant change in performance indicators, give the so-called leverage effect or leverage effect.

The purpose of this study is to study methods for calculating and analyzing the operating leverage in managing the financial mechanism of an enterprise. To achieve this goal, the following tasks were presented:

1) consider the concept and use of operating leverage;

2) study the effect of operating leverage;

3) consider the relationship between the effect of operating leverage and the entrepreneurial risk of the enterprise.

The relevance of this work is due to the fact that every enterprise today seeks to maximize its profits, and the operating or production leverage is the potential opportunity to influence the balance sheet profit by changing the cost structure and output volume.

1 The essence, concept and methods of calculating the operating leverage in

financial management

1.1 The concept of operating leverage

IN modern conditions at Russian enterprises, the issues of mass regulation and profit dynamics come to one of the first places in the management of financial resources. The solution of these issues is included in the scope of operational (production) financial management. It is known that entrepreneurial activity is associated with many factors that affect its result. All of them can be divided into two groups. The first group of factors is associated with profit maximization through supply and demand, pricing policy, product profitability, and its competitiveness. Another group of factors is associated with the identification critical indicators by volume of products sold, the best combination of marginal revenue and marginal costs, with the division of costs into variable and fixed.

Operating leverage is closely related to the cost structure. Operating leverage or production leverage (leverage in literal translation - leverage) is a mechanism for managing the profit of an enterprise based on optimizing the ratio of fixed and variable costs. With its help, you can predict the change in the profit of the enterprise depending on the change in sales volume, as well as determine the break-even point.

A necessary condition for the application of the mechanism of operating leverage is the use of the marginal method based on the division of the company's costs into fixed and variable. The lower the share of fixed costs in the total cost of the enterprise, the more the amount of profit changes in relation to the rate of change in the company's revenue.

As already mentioned, there are two types of costs in the enterprise: variable and fixed. Their structure as a whole, and in particular the level of fixed costs, in the total revenue of an enterprise or in revenue per unit of production can significantly affect the trend in profits or costs. This is due to the fact that each additional unit of production brings some additional contribution, which goes to cover fixed costs, and depending on the ratio of fixed and variable costs in the company's cost structure, the total increase in contribution from an additional unit of goods can be expressed in a significant jump. change in profit. As soon as the break-even point is reached, there is profit, which begins to grow faster than sales. The operating lever is a tool for defining and analyzing this dependence. In other words, it is designed to establish the impact of profit on the change in sales.

The level of operating leverage is calculated as:

Where OR is the level of operating leverage.

1.2 The effect of operating leverage. Essence and calculation methods

the impact forces of operational analysis

Operational analysis works with such parameters of the company's activities as costs, sales volume and profit. Great importance for operational analysis has a division of costs into fixed and variable. The main values ​​used in operational analysis are: gross margin (coverage amount), operating leverage strength, profitability threshold (break-even point), financial safety margin.

Gross margin (coverage amount). This value is calculated as the difference between sales revenue and variable costs. It shows whether the company has enough funds to cover fixed costs and make a profit.

The force of the operating lever. It is calculated as the ratio of gross margin to profit after interest, but before income tax.

The dependence of the financial results of the enterprise's operating activities, with other equal conditions, from assumptions related to changes in the volume of production and sales marketable products, fixed costs and variable costs of production, is the content of the analysis of operating leverage.

The impact of an increase in the volume of production and sales of marketable products on the profit of an enterprise is determined by the concept of operating leverage, the impact of which is manifested in the fact that a change in revenue is accompanied by a stronger dynamics of change in profit.

Together with this indicator, when analyzing the financial and economic activities of an enterprise, the magnitude of the effect of the operating leverage (leverage) is used, which is the reciprocal of the security threshold:

or ,

where ESM is the effect of operating leverage.

Operating leverage shows how much profit will change if revenue changes by 1%. The effect of operating leverage is that a change in sales revenue (expressed as a percentage) always results in a larger change in profit (expressed as a percentage). The strength of operating leverage is a measure of the entrepreneurial risk associated with an enterprise. The higher it is, the greater the risk to shareholders.

The value of the operating leverage effect found using the formula is further used to predict the change in profit depending on the change in the company's revenue. To do this, use the following formula:

,

where D BP - change in revenue in%; D P - change in profit in%.

Example 1 .

The management of the Technologiya enterprise intends to increase sales revenue by 10% (from UAH 50,000 to UAH 55,000) due to the growth in sales of electrical goods, while not going beyond the relevant period. The total variable costs for the initial version are UAH 36,000. Fixed costs are equal to 4,000 UAH. You can calculate the amount of profit in accordance with the new revenue from the sale of products in the traditional way or using operating leverage.

Traditional method:

1. The initial profit is 10,000 UAH. (50,000 - 36,000 - 4,000).

2. Variable costs for the planned volume of production will increase by 10%, that is, they will be equal to UAH 39,600. (36,000 x 1.1).

3. New profit: 55,000 - 39,600 - 4,000 = UAH 11,400.

Operating lever method :

1. The strength of the influence of the operating lever: (50,000 - 36,000 / / 10,000) = 1.4. This means that a 10% increase in revenue should bring a profit increase of 14% (10 x 1.4), that is, 10,000 x 0.14 = 1,400 UAH.

The effect of operating leverage is that any change in sales revenue results in an even larger change in profit. The action of this effect is associated with the disproportionate impact of conditionally fixed and conditionally variable costs on the financial result when the volume of production and sales changes. The higher the share of semi-fixed costs and production costs, the stronger the impact of operating leverage. Conversely, with an increase in sales, the share of semi-fixed costs falls and the impact of operating leverage falls.

Profitability threshold (break-even point) is an indicator that characterizes the volume of product sales, at which the company's revenue from the sale of products (works, services) is equal to all its total costs. That is, this is the volume of sales at which the business entity has neither profit nor loss.

In practice, three methods are used to calculate the break-even point: graphical, equations, and marginal income.

At graphic method finding the break-even point is reduced to building a comprehensive schedule of "costs - output - profit". The sequence of constructing the graph is as follows: a line of fixed costs is drawn on the graph, for which a straight line is drawn parallel to the x-axis; on the x-axis, a point is selected, that is, a volume value. To find the break-even point, the value of total costs (fixed and variable) is calculated. A straight line is drawn on the graph corresponding to this value; again, any point on the abscissa axis is selected and for it the amount of proceeds from the sale is found. A straight line is constructed corresponding to the given value.

Direct lines show the dependence of variable and fixed costs, as well as revenue on the volume of production. The point of the critical volume of production shows the volume of production at which the proceeds from the sale is equal to its full cost. After determining the break-even point, profit planning is based on the effect of the operating (production) leverage, that is, the margin of financial strength at which the company can afford to reduce the volume of sales without leading to a loss. At the break-even point, the revenue received by the enterprise is equal to its total costs, while the profit is zero. The revenue corresponding to the break-even point is called the threshold revenue. The volume of production (sales) at the break-even point is called the threshold volume of production (sales). If the company sells products less than the threshold sales volume, then it suffers losses; if more, it makes a profit. Knowing the threshold of profitability, you can calculate the critical volume of production:

Margin of financial strength. This is the difference between the company's revenue and the threshold of profitability. The margin of financial safety shows how much revenue can decrease so that the company still does not incur losses. The margin of financial strength is calculated by the formula:

FFP = VP - RTHRESHOLD

The higher the power of influence of the operating lever, the lower the margin of financial strength.

Example 2 . Calculation of the impact force of the operating lever

Initial data:

Proceeds from the sale of products - 10,000 thousand rubles.

Variable costs - 8300 thousand rubles,

Fixed costs - 1500 thousand rubles.

Profit - 200 thousand rubles.

1. Calculate the force of the operating leverage.

Coverage amount = 1500 thousand rubles. + 200 thousand rubles. = 1700 thousand rubles.

Operating lever force = 1700 / 200 = 8.5 times

2. Let's assume that next year sales growth is predicted by 12%. We can calculate by what percentage the profit will increase:

12% * 8,5 =102%.

10000 * 112% / 100= 11200 thousand rubles

8300 * 112% / 100 = 9296 thousand rubles.

11200 - 9296 = 1904 thousand rubles

1904 - 1500 = 404 thousand rubles

Lever force = (1500 + 404) / 404 = 4.7 times.

From here, profit increases by 102%:

404 - 200 = 204; 204 * 100 / 200 = 102%.

Let's define the profitability threshold for this example. For these purposes, the gross margin ratio should be calculated. It is calculated as the ratio of gross margin to sales revenue:

1904 / 11200 = 0,17.

Knowing the gross margin ratio - 0.17, we consider the profitability threshold.

Profitability threshold \u003d 1500 / 0.17 \u003d 8823.5 rubles.

Analysis of the cost structure allows you to choose a strategy of behavior in the market. There is a rule for choosing profitable options assortment policy - the rule "50: 50".

The calculation of the above values ​​makes it possible to assess the sustainability of the company's entrepreneurial activity and the entrepreneurial risk associated with it.

And if in the first case the chain is considered:

Cost (Cost) - Volume (Sales proceeds) - Profit (Gross profit), which makes it possible to calculate the profitability indicator of turnover, the self-sufficiency ratio and the indicator of profitability of production by costs, then when calculating cash flows, we have an almost similar scheme:

outflow Money- Cash inflow - Net cash flow, (Payments) (Receipts) (Difference) which makes it possible to calculate various indicators of liquidity and solvency.

However, in practice, a situation arises when an enterprise has no money, but there is a profit, or there are funds, but there is no profit. The problem lies in the mismatch in time of movement of material and cash flows. In most sources of modern financial and economic literature, the problem of liquidity - profitability is considered within the framework of management working capital and is missed when analyzing enterprise cost management processes.

Although in this perspective, the most significant bottlenecks in the functioning of domestic industrial enterprises: payment, or rather "non-payment" discipline, problems of dividing costs into fixed and variable, access to the problem of intra-company pricing, the problem of assessing cash receipts and payments over time.

Theoretically interesting is the fact that when considering the CVP model in the context of cash flows, the behavior of the so-called fixed and variable costs changes completely. It becomes possible to plan the level of "real" rather than prospective profitability within shorter periods, based on agreements for the repayment of accounts payable and receivable.

The use of the operational analysis of the standard model is complicated not only by the above limitations, but also by the specifics of the preparation of financial statements (once a quarter, half a year, a year). For the purposes of operational management of costs and results, this frequency is clearly not enough.

Differences in the structure of the assortment of the enterprise are also the "bottleneck" of this type of cost analysis. Given the difficulty of dividing mixed costs into fixed and variable parts, the problems with the further distribution of allocated and "pure" fixed costs for a specific type of product, the break-even point for a specific type of enterprise product will be calculated with significant assumptions.

In order to obtain more timely information and limit assortment assumptions, it is proposed to use a methodology that directly takes into account the movement of financial flows (payments for cost items and receipts for specific products sold, which ultimately form the cost of production and sales revenue).

The production activity of the majority of industrial enterprises is regulated by certain technologies, state standards and established terms of settlements with creditors and debtors. For this reason, it is necessary to consider the methodology in the context of cash flow cycles, production cycles.

There is a direct relationship between operating leverage and entrepreneurial risk. That is, the greater the operating leverage (the angle between revenue and total costs), the greater the entrepreneurial risk. But at the same time, the higher the risk, the greater the reward.

1 - sales proceeds; 2 - operating profit; 3 - operating losses; 4 - total costs; 5 - breakeven point; 6 - fixed costs.

Rice. 1.1 Low and high operating leverage

The effect of operating leverage is that any change in sales revenue (due to a change in volume) leads to an even greater change in profit. The action of this effect is associated with the disproportionate influence of fixed and variable costs on the result of the financial and economic activity of the enterprise when the volume of production changes.

The strength of the impact of the operating lever shows the degree of entrepreneurial risk, that is, the risk of loss of profit associated with fluctuations in the volume of sales. The greater the effect of operating leverage (the greater the proportion of fixed costs), the greater the entrepreneurial risk.

As a rule, the higher the fixed costs of the enterprise, the higher the entrepreneurial risk associated with it. In turn, high fixed costs are usually the result of a company having expensive fixed assets that need maintenance and periodic repairs.

1.3 Three components of operating leverage

The main three components of operating leverage are fixed costs, variable costs and price. All of them, to one degree or another, are related to the volume of sales. By changing them, managers can influence sales. Change in fixed costs If managers can significantly cut fixed cost items, for example by cutting overheads, the minimum breakeven volume can be significantly reduced. As a result, the effect of the accelerated change in profits will start to work at a lower level.
1 - new minimum break-even volume 2 - old minimum break-even volume Reduced fixed costs by 25% from 200 tr. up to 150 tr. led to a shift in the break-even point to the left by 100 pcs. or 25% from 400 pcs. up to 300 pcs. As you can see from the figure, reducing fixed costs is a direct and effective way to reduce the minimum break-even volume in order to increase the profitability of the firm. Changing variable costs A decrease in direct variable costs of production leads to an increase in the indemnity that each additional unit brings, which in turn affects the increase in profits, as well as a shift in the break-even point. Reducing direct variable costs can be achieved by switching to new, more modern production materials or by switching to a supplier that offers less expensive components.
1 - new minimum break-even volume 2 - old minimum break-even volume up to 356 pcs. As we can see, this shift is less significant than with the same share of reduction in fixed costs. The reason for this lies in the fact that the reduction applies only to a small fraction of the total cost of production, since in this example the variable costs are relatively small. Price change If the change in fixed and variable costs in most cases is controlled by management, then the price change in most cases is dictated by the market demand. A change in the price of a product usually affects the market equilibrium and directly affects the volume of production in physical terms. As a result, the analysis of price changes will not be enough to determine its impact on break-even, since as a result of price changes, the volume of products sold will also change. In other words, a change in price may have a disproportionate effect on the volume of products sold. An increase in price can shift the break-even point to the left, but at the same time significantly reduce the volume of products sold, which will lead to a loss of profit. Also, an increase in price can shift the break-even point to the right, but at the same time increase the volume of sales so much that profits increase very significantly.
As we can see, as a result of reducing the price of products by 100r. The break-even point has shifted 100 pcs. to the right. That is, now, in order to achieve the same level of profit as before, the company must sell 100 units. additionally. As we can see, the change in price affects internal results, but often it has an even greater effect on the market. Therefore, if immediately after the price reduction, competitors in the market also reduced their prices, then this decision was erroneous, since everyone's profits decreased. If the advantage in increased sales volume can be obtained over a long period of time, then the decision to reduce the price was correct. Therefore, when changing prices, it is necessary to take into account the requirements of the market more than the internal needs of the enterprise.

2 Using the operating lever

Production leverage is an indicator that helps managers choose the optimal strategy for the enterprise in managing costs and profits. The value of the production lever can change under the influence of:

Prices and sales volume;

Variable and fixed costs;

Combinations of any of the above factors.

The change in the effect of the production lever is based on the change in the share of fixed costs in the total cost of the enterprise. At the same time, it must be borne in mind that the sensitivity of profit to changes in sales volume can be ambiguous in enterprises with a different ratio of fixed and variable costs. The lower the share of fixed costs in the total cost of the enterprise, the more the amount of profit changes in relation to the rate of change in the company's revenue.

It should be noted that in specific situations, the manifestation of the mechanism of production leverage has a number of features that must be taken into account in the process of its use. These features are as follows:

1. The positive impact of the production lever begins to manifest itself only after the enterprise has overcome the break-even point of its activities.

In order for the positive effect of the production lever to begin to manifest itself, the enterprise must first receive a sufficient amount of marginal income to cover its fixed costs. This is due to the fact that the company is obliged to reimburse its fixed costs regardless of the specific volume of sales, therefore, the higher the amount of fixed costs, the later, all other things being equal, it will reach the break-even point of its activities. In this regard, until the enterprise has ensured the break-even of its activities, a high level of fixed costs will be an additional “burden” on the way to reaching the break-even point.

2. As sales increase further and move away from the breakeven point, the effect of production leverage begins to decline. Each subsequent percentage increase in sales will lead to an increasing rate of increase in the amount of profit.

3. The mechanism of industrial leverage also has the opposite direction - with any decrease in sales, the size of the enterprise's profit will decrease even more.

4. There is an inverse relationship between the production leverage and the profit of the enterprise. The higher the profit of the enterprise, the lower the effect of production leverage and vice versa. This allows us to conclude that production leverage is a tool that equalizes the ratio of the level of profitability and the level of risk in the process of carrying out production activities.

5. The effect of production leverage appears only in a short period. This is determined by the fact that the fixed costs of the enterprise remain unchanged only for a short period of time. As soon as the next jump in the amount of fixed costs occurs in the process of increasing sales, the enterprise needs to overcome a new break-even point or adapt its production activities to it. In other words, after such a jump, the effect of production leverage manifests itself in new economic conditions in a new way.

With unfavorable commodity market conditions that determine a possible decrease in sales, 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 fixed costs of the enterprise. And vice versa, with a favorable commodity market situation and the presence of a certain margin of safety, the requirements for the implementation of a regime of saving fixed costs can be significantly weakened. During such periods, an enterprise can significantly expand the volume of real investments by reconstructing and modernizing fixed production assets.

When managing fixed costs, it should be borne in mind that their high level is largely determined by the industry specifics of the activity that determine different level capital intensity of manufactured products, differentiation of the level of mechanization and automation of labor. In addition, it should be noted that fixed costs are less amenable to rapid change, so enterprises with a high value of production leverage lose flexibility in managing their costs.

However, despite these objective constraints, each enterprise has enough opportunities to reduce, if necessary, the amount and proportion of fixed 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 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. Providing these savings before the company overcomes the break-even point leads to an increase in marginal income, which allows you to quickly overcome this point. After breaking the break-even point, 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: reducing the number of employees in the main and auxiliary industries by ensuring the growth of their labor productivity; reduction in the size of stocks of raw materials, materials and 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.

An analysis of the properties of the operating leverage arising from its definition allows us to draw the following conclusions: 1. With the same total costs, the operating leverage is greater, the smaller the share of variable costs or the greater the share of fixed costs in the total cost. 2. The operating leverage is higher, the closer to the break-even point the volume of actual sales is “located”, which is the reason for the high risk. 3. A low leverage situation comes with less risk but also less reward in the profit formula. Based on the results of the operational analysis, we can conclude that the company is attractive to investors because it has: a) sufficient (more than 10%) margin of financial strength; b) a favorable value of the impact force of the operating lever with a reasonable proportion of fixed costs in the total cost.

Understanding the essence of the operating lever and the ability to manage it provide additional opportunities for using this tool in the company's investment policy. Thus, production risk in all industries can be regulated to a certain extent by managers, for example, when choosing projects with higher or lower fixed costs. With the release of products with a high market capacity, with the confidence of managers in sales volumes that significantly exceed the break-even point, it is possible to use technologies that require high fixed costs, implement investment projects for the installation of highly automated lines, and other capital-intensive technologies. In the areas of activity, when the company is confident in the possibility of conquering a stable market segment, as a rule, it is advisable to implement projects that have a lower proportion of variable costs.

The general conclusion is:

An enterprise with a higher operational risk takes more risks in the event of a deterioration in market conditions, and at the same time it has advantages in the event of an improvement in the market situation;

The enterprise must navigate the market situation and adjust the cost structure accordingly.

Cost management in connection with the use of the effect of operating leverage allows you to quickly and comprehensively approach the use of enterprise finances. You can use the 50/50 rule for this.

All types of products are divided into two groups depending on the share of variable costs. If it is more than 50%, then it is more profitable for the given types of products to work on reducing costs. If the share of variable costs is less than 50%, then it is better for the company to increase sales volumes - this will give more gross margin.

Having mastered the cost management system, the company receives the following benefits:

The ability to increase the competitiveness of manufactured products (services) by reducing costs and increasing profitability;

Develop a flexible pricing policy, based on it, increase turnover and drive out competitors;

Save the material and financial resources of the enterprise, obtain additional working capital;

Evaluate the effectiveness of the activities of the company's divisions, staff motivation.

Conclusion

Understanding the mechanism of manifestation of production leverage allows you to purposefully manage the ratio of fixed and variable costs in order to increase the efficiency of production and economic activities under various trends in the commodity market and the stage of the life cycle of an enterprise.

The use of the mechanism of production leverage, targeted management of fixed and variable costs, the rapid change in their ratio under changing business conditions will increase the potential for generating profits for the enterprise.

Thus, modern cost management involves quite diverse approaches to accounting and analysis of costs, profits, business risk. You have to master these interesting tools to ensure the survival and development of your business.

Understanding the essence of the operating lever and the ability to manage it provide additional opportunities for using this tool in the company's investment policy. Thus, production risk in all industries can be regulated to a certain extent by managers, for example, when choosing projects with higher or lower fixed costs. With the release of products with a high market capacity, with the confidence of managers in sales volumes that significantly exceed the break-even point, it is possible to use technologies that require high fixed costs, implement investment projects for the installation of highly automated lines, and other capital-intensive technologies. In the areas of activity, when the company is confident in the possibility of conquering a stable market segment, as a rule, it is advisable to implement projects that have a lower proportion of variable costs.

The different degree of influence of variable and fixed costs on the amount of profit when changing production volumes causes the effect of operating leverage (production leverage). It consists in the fact that any change in sales volumes causes a stronger change in profits. In addition, the strength of operating leverage increases with an increase in the proportion of fixed costs.

An analysis of the properties of the operating lever, arising from its definition, allows us to draw the following conclusions:

1. With the same total costs, the greater the operating leverage, the smaller the share of variable costs or the greater the share of fixed costs in the total cost.

2. The operating leverage is higher, the closer to the break-even point the volume of actual sales is “located”, which is the reason for the high risk.

3. A low leverage situation comes with less risk but also less reward in the profit formula. According to the results of the operational analysis, it can be concluded that the company is attractive to investors because it has:

a) sufficient (more than 10%) margin of financial strength;

b) a favorable value of the impact force of the operating lever with a reasonable proportion of fixed costs in the total cost.

It can be noted that the weaker the impact of the operating leverage, the greater the margin of financial strength. The strength of the impact of the operating lever, as already noted, depends on the relative magnitude of fixed costs, which, with a decrease in the income of the enterprise, are difficult to reduce. high strength the impact of the operating leverage in conditions of economic instability, the fall in the effective demand of consumers means that each percentage of the decline in revenue leads to a significant drop in profits and the possibility of the company entering the zone of losses. If we define the risk of a particular enterprise as an entrepreneurial risk, then we can trace the following relationships between the strength of the operating leverage and the degree of entrepreneurial risk: with a high level of fixed costs of the enterprise and the absence of their reduction during the period of falling demand for products, entrepreneurial risk increases. For small enterprises specializing in the production of one type of product, it is typical high degree entrepreneurial risk. In the same direction, the instability of demand and prices for finished products, prices for raw materials and energy resources.

Bibliography:

1. Analysis and diagnostics of the financial and economic activities of the enterprise. P.P., Vikulenko A.E., Ovchinnikova L.A. and etc.: Tutorial for universities / Edited by P.P. Taburchak, V.M. Tumin and M.S. Saprykin. - Rostov n. / D: Phoenix, 2002. - 352C.

2. Ansoff I. Strategic management. - M.: Economics, 2003

3. Balabanov I.T. Fundamentals of financial management. How to manage capital? - M. "Finance and statistics", 2003.

4. Balabanov I.T. Financial analysis and planning of an economic entity. - 2nd ed., add. - M.: Finance and statistics, 2001. - 208C.

5. Blank I.A. Capital Management. - Kyiv.: Elga, Nika-Center, 2004. - 574С.

6. Guskova E.A., Orlova A.I. Operational leverage as a tool for profit management and forecasting.// Economist's Handbook. - 2004. - No. 2. -19 - 27C.

7. Efimova O.V. How to analyze the financial position of the company. - M.: Intel-Sintez, 2002.

8. Pavlova L.N. Financial management. Cash flow management of the enterprise: Textbook. - M.: "Banks and exchanges", "UNITI", 2001.

9. Ruzhanskaya N.V. Features of calculating financial leverage in Russian practice financial management // Financial management No. 6, 2005.

10. Ryndin A.G., Shamaev G.A. Organization of financial management at the enterprise. - M.: Publishing house "RDD", 1999.

11. Selezneva N.N. Ionova A.F. The financial analysis. Financial management: Proc. Allowance for universities. - 2nd ed., revised. and additional - M.: UNITI-DANA, 2003. - 639C.

12. Financial management: theory and practice: Textbook. / Ed. E.S. Stoyanova. – 5th ed., revised. and additional - M .: Perspective, 2000. - 656C.

13. Finance. Proc. allowance / Ed. prof. A.M. Kovaleva. - M.: Finance and statistics, 1996.

14. Sheremet A.D., Saifulin R.S. Enterprise finance. - M.: "INFRA-M", 1997.

15. Sheremet A.D., Saifullin R.S. Methods of financial analysis. - M.: INFRA-M, 1995. - 176C.

The concept of "leverage" comes from the English "leverage - the action of a lever", and means the ratio of one value to another, with a small change in which the indicators associated with it change greatly.

The most common types of leverage are:

• Production (operational) leverage.
• financial leverage.

All companies use financial leverage to some extent. The whole question is what is a reasonable ratio between own and borrowed capital.

Financial leverage ratio(shoulder of financial leverage) is defined as the ratio of borrowed capital to equity capital. It is best to calculate it according to the market valuation of assets.

The effect of financial leverage is also calculated:

EGF \u003d (1 - Kn) * (ROA - Zk) * ZK / SK.

• where ROA - return on total capital before taxes (the ratio of gross profit to the average value of assets),%;
• SC - the average annual amount of own capital;
• Kn - taxation coefficient, in the form of a decimal fraction;
• Tsk - weighted average price of borrowed capital, %;
• ZK - the average annual amount of borrowed capital.

The formula for calculating the effect of financial leverage contains three factors:

(1 - Kn) - does not depend on the enterprise.

(ROA - Tsk) - the difference between the return on assets and the interest rate for a loan. It is called differential (D).

(LC/SK) - financial leverage (FR).

You can write the formula for the effect of financial leverage in a shorter way:

EGF \u003d (1 - Kn)? D? FR.

The effect of financial leverage shows by what percentage the return on equity is increased by attracting borrowed funds. The effect of financial leverage arises due to the difference between the return on assets and the cost of borrowed funds. The recommended EGF value is 0.33 - 0.5.

The effect of financial leverage is that, other things being equal, the use of leverage leads to the fact that the growth of the corporation's earnings before interest and taxes leads to a stronger increase in earnings per share.

The effect of financial leverage is also calculated taking into account the effect of inflation (debts and interest on them are not indexed). As inflation rises, the cost of borrowing becomes lower ( interest rates fixed) and the result from their use is higher. However, if interest rates are high or the return on assets is low, financial leverage begins to work against owners.

Leverage is a very risky business for those enterprises whose activities are cyclical. As a result, several consecutive years of low sales can lead heavily leveraged businesses to bankruptcy.

For a more detailed analysis of the change in the value of the financial leverage ratio and the factors that influenced it, the method of the 5-factor financial leverage ratio is used.

Thus, financial leverage reflects the degree of dependence of the enterprise on creditors, that is, the magnitude of the risk of loss of solvency. In addition, the company gets the opportunity to take advantage of the "tax shield", since, unlike dividends on shares, the amount of interest on the loan is deducted from the total amount of profit subject to taxation.

Operating leverage (operating leverage) shows how many times the rate of change in sales profit exceeds the rate of change in sales revenue. Knowing the operating leverage, it is possible to predict the change in profit with a change in revenue.

It is the ratio of a company's fixed to variable costs and the impact of this ratio on earnings before interest and taxes (operating income). Operating leverage shows how much profit will change if revenue changes by 1%.

The price operating leverage is calculated by the formula:

Rts \u003d (P + Zper + Zpost) / P \u003d 1 + Zper / P + Zpost / P

where: B - sales revenue.

P - profit from sales.

Zper - variable costs.

Zpost - fixed costs.

Rts - price operating leverage.

pH is a natural operating lever.

Natural operating leverage is calculated by the formula:

Rn \u003d (V-Zper) / P

Considering that B \u003d P + Zper + Zpost, we can write:

Rn \u003d (P + Zpost) / P \u003d 1 + Zpost / P

Operating leverage is used by managers to balance different types of costs and increase revenue accordingly. Operating leverage makes it possible to increase profits when the ratio of variable and fixed costs changes.

The position that fixed costs remain unchanged when the volume of production changes, while variables increase linearly, makes it possible to significantly simplify the analysis of operating leverage. But it is known that real dependencies are more complicated.

With an increase in the volume of production, variable costs per unit of output can both decrease (the use of progressive technological processes, improving the organization of production and labor), and increase (growth of losses in marriage, decrease in labor productivity, etc.). Revenue growth is slowing down due to declining commodity prices as the market saturates.

Financial leverage and operating leverage are closely related methods. As with operating leverage, financial leverage raises fixed costs in the form of high interest payments on loans, but because lenders do not participate in the company's income distribution, variable costs are reduced. Accordingly, increased financial leverage also has a twofold effect: more operating income is required to cover fixed financial costs, but when cost recovery is achieved, profits begin to grow faster with each unit of additional operating income.

The combined effect of operating and financial leverage is known as the effect common leverage and is their product:

Total lever = OL x FL

This indicator gives an idea of ​​how a change in sales will affect the change in net income and earnings per share of the enterprise. In other words, it will allow you to determine by what percentage the net profit will change if the sales volume changes by 1%.

Therefore, production and financial risks are multiplied and form the total risk of the enterprise.

Thus, both financial and operational leverage, both potentially effective, can be very dangerous due to the risks they contain. The trick, or rather skillful financial management, is to balance these two elements.

Sincerely, Young Analyst

Definition

Operating leverage effect ( English Degree of Operating Leverage, DOL) is a coefficient that shows the degree of management efficiency fixed costs and the degree of their impact on operating income ( English Earnings before interest and taxes, EBIT). In other words, the ratio shows how much the operating income will change if the volume of sales proceeds changes by 1%. Companies with a high ratio are more sensitive to changes in sales volume.

High or low operating lever

The low value of the operating leverage ratio indicates the prevailing share of variable expenses in the total expenses of the company. Thus, sales growth will have a weaker impact on operating income growth, but such companies need to generate lower sales revenue to cover fixed costs. Ceteris paribus, such companies are more stable and less sensitive to changes in sales.

The high value of the operating leverage ratio indicates the predominance of fixed costs in the structure of the company's total costs. Such companies receive a higher increase in operating income for each unit of increase in sales, but are also more sensitive to its decrease.

It is important to remember that a direct comparison of the operating leverage of companies from different industries is incorrect, since industry specifics largely determine the ratio of fixed and variable costs.

Formula

There are several approaches to calculating the effect of operating leverage, which, nevertheless, lead to the same result.

In general, it is calculated as the ratio of the percentage change in operating income to the percentage change in sales.

Another approach to calculating the operating leverage ratio is based on the marginal profit ( English Contribution Margin).

This formula can be transformed as follows.

where S - sales revenue, TVC - total variable costs, FC - fixed costs.

Also, the operating leverage can be calculated as the ratio of the contribution margin ratio ( English Contribution Margin Ratio) to the operating margin ( English Operating Margin Ratio).

In turn, the marginal profit ratio is calculated as the ratio of marginal profit to sales proceeds.

The operating profit ratio is calculated as the ratio of operating income to sales revenue.

Calculation example

In the reporting period, the companies demonstrated the following indicators.

Company A

• Percent change in operating income +20%
• Percent change in sales revenue +16%

Company B

• Sales proceeds 5 mln.
• Total variable costs 2.5 million c.u.
• Fixed costs 1 million c.u.

Company B

• Sales proceeds 7.5 mln.
• Cumulative marginal profit of 4 million c.u.
• Operating profit ratio 0.2

The operating leverage ratio for each of the companies will be as follows:

Let's assume that each company has a 5% increase in sales. In this case, Company A's operating income will increase by 6.25% (1.25×5%), Company B by 8.35% (1.67×5%), and Company C by 13.35% ( 2.67×5%).

If all companies experience a 3% decrease in sales, Company A's operating income will decrease by 3.75% (1.25×3%), Company B's by 5% (1.67×3%), and Company B by 8% (2.67×3%).

A graphical interpretation of the impact of operating leverage on the amount of operating income is shown in the figure.

As you can see from the chart, Company B is the most vulnerable to a decline in sales, while Company A will show the most resilience. On the contrary, with an increase in sales volume, Company B will show the highest growth rate of operating income, and Company A will show the lowest.

conclusions

As mentioned above, companies with high operating leverage are vulnerable to even small declines in sales. In other words, a few percent drop in sales can result in a significant loss of operating income or even an operating loss. On the one hand, such companies must carefully manage their fixed costs and accurately predict changes in sales volume. On the other hand, in favorable market conditions, they have a higher potential for operating income growth.