Financial and operational leverage. Operating and financial leverage: concept and definition of the effect of leverage Financial and operating leverage a

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

Most common the following types leverage:

Production (operational) leverage.
Financial leverage.

All companies use financial leverage to one degree or another. The whole question is what is the reasonable ratio between equity and debt capital.

Financial leverage ratio(leverage) is defined as the ratio of debt to equity capital. It is most correct to calculate it according to market valuation assets.

The effect of financial leverage is also calculated:

EGF = (1 - Kn)*(ROA - Tsk) * ZK/SK.

where ROA is the return on total capital before taxes (the ratio of gross profit to the average value of assets), %;
SK - average annual amount equity;
Кн - taxation coefficient, in the form of a decimal fraction;
Tsk - weighted average price of borrowed capital, %;
ZK - 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 return on assets and the interest rate for the loan. It is called differential (D).

(ZK/SC) - financial leverage (LF).

You can write the formula for the effect of financial leverage in short:

EGF = (1 - Kn) ? D? FR.

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

The resulting effect of financial leverage is that the use of debt, ceteris paribus, leads to the fact that the growth of corporate 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 effects of inflation (debts and interest on them are not indexed). As the inflation rate increases, the fee for using borrowed funds becomes lower (interest rates are 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 the owners.

Leverage is a very risky business for those enterprises whose activities are cyclical in nature. As a result, several consecutive years low sales can lead enterprises burdened with high leverage to bankruptcy.

For a more detailed analysis of changes in the value of the financial leverage ratio and the factors that influenced it, use the 5-factor financial leverage ratio methodology.

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 has the opportunity to take advantage of a “tax shield”, since, unlike dividends on shares, the amount of interest on the loan is deducted from the total 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, you can predict changes in profit when revenue changes.

It is the ratio of a company's fixed to variable expenses and the effect that ratio has on earnings before interest and taxes (operating profit). Operating leverage shows by what percentage profit will change if revenue changes by 1%.

Price operating leverage is calculated using the formula:

Rts = (P + Zper + Zpost)/P =1 + Zper/P + Zper/P

where: B - sales revenue.

P - profit from sales.

Zper - variable costs.

Zpost - fixed costs.

Рс - price operating leverage.

pH is a natural operating lever.

Natural operating leverage is calculated using the formula:

Rn = (V-Zper)/P

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

Рн = (P + Zpost)/P = 1 + Zpost/P

Operating leverage is used by managers to balance different kinds costs and increase income 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 production volume changes, and variable costs increase linearly, makes it possible to significantly simplify the analysis of operating leverage. But it is known that real dependencies are more complicated.

With increasing production volume variable costs per unit of production can either decrease (use of progressive technological processes, improving the organization of production and labor) and increase (increasing losses due to defects, decreasing labor productivity, etc.). Revenue growth rates are slowing down due to lower product prices as the market becomes saturated.

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

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

Total leverage = OL x FL

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

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

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

Sincerely, Young Analyst

Financial leverage (financial leverage)- this is the ratio of a company's debt capital to its own funds; it characterizes the degree of risk and stability of the company. The lower the financial leverage, the more stable the situation. On the other side, borrowed capital allows you to increase the return on equity ratio, i.e. get additional profit on your own capital.

An indicator reflecting the level of additional profit when using borrowed capital is called effect of financial leverage. It is calculated using the following formula:

EGF = (1 - Sn) × (KR - Sk) × ZK/SK, where:

Calculation formula the financial leverage effect contains three factors:

We can draw 2 conclusions:

The effectiveness of the use of borrowed capital depends on the ratio between the return on assets and the interest rate for the loan. If the rate for a loan is higher than the return on assets, the use of borrowed capital is unprofitable. All other things being equal b O greater financial leverage gives b O greater effect.

The minimum amount of revenue required to cover all expenses is called break-even point, in turn, how much revenue can decrease for the enterprise to operate without losses shows financial safety margin.

A change in revenue can be caused by a change in price, a change in physical sales volume, or a change in both of these factors.

Let us introduce the following notation:

The price operating leverage is calculated using the formula: Рц = В/П

Rts = (P + Zper + Zpost)/P =1 + Zper/P + Zper/P

Natural operating leverage calculated by the formula:

Rn = (V-Zper)/P

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

Рн = (P + Zpost)/P = 1 + Zpost/P

Comparing formulas for operating leverage in price and in kind you can notice that Rn has less impact. This is explained by the fact that with an increase in natural volumes, variable costs simultaneously increase, and with a decrease, they decrease, which leads to a slower increase/decrease in profits.

The idea of operating leverage is the same as financial leverage. ( Financial leverage- this is the economic profitability of own funds). IN financial management There are concepts of constant capital (equity - SS) and variable capital (borrowed funds - LC).

When increasing/decreasing production volumes, it is difficult to quickly change the value of the constant, but you can easily change the amount of borrowed capital and bring the amount of capital used into line with the new production volume. The financial leverage that arises in this case - the ratio between AP and SS - directly affects the return on equity. The action of operating leverage is based on the fact that there are fixed costs that do not change even with a significant change in production volumes, and variable costs that are directly proportional to this volume. Therefore, when increasing/reducing production volumes

the ratio between variable and fixed costs (operating leverage) changes and, as a result, profits increase/decrease disproportionately to the change in the volume of activity. An important object of analysis is the price set by the market for products, into which the enterprise needs to fit its costs and still make a profit. If the direct costs per unit of production (cost of materials, workers' wages, electricity, etc.) exceed the price, then such technology is not viable and production should be stopped. This will be the only thing management decision. The problem arises in the normal situation when direct costs are less than the market price. In this case, with small volumes of production, revenue from sales of products is too small to stop the fixed costs associated with the operation of the enterprise, and it becomes unprofitable. As production volumes increase, revenue grows and, at a certain amount, will cover all costs of production and sales of products, but still does not provide a profit. This is the so-called critical point. Further growth in production volumes leads to increased profits. THAT. The main idea of the analysis is to compare three variables: “Costs - Production volume - Profit” key concepts: Fixed costs- depreciation, remuneration of management personnel, administrative expenses, interest on loans, etc., which do not change with changes in production volume. Variable costs- cost of raw materials, wages of workers, power electricity, transport costs, trade and commission costs, etc., which vary in direct proportion to the volume of production. There are three ways to divide total costs into fixed and variable costs - the high-low point method, the graphical method, and the least squares method. Gross Margin- (French - difference, margin) - the difference between sales revenue and variable costs, or the sum of fixed costs and profit. Profit- the difference between the gross margin and fixed costs or between sales revenue and the sum of fixed and variable costs.

SOP (strength of operating leverage) = (BP - PrI) / Profit. In Qcr the influence of PSI is very large

As operating leverage increases, business risk increases. Good PR/PSI ratio = 70/30.

Operating leverage(production leverage) is the potential opportunity to influence the company’s profit by changing the cost structure and production volume.

Operating leverage effect manifests itself in the fact that any change in sales revenue always leads to a stronger change in profit. This effect is caused by varying degrees of influence of the dynamics of variable costs and fixed costs on financial results 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 your profit will increase.

The level or strength of the operating leverage (Degree operating leverage, DOL) is calculated using the formula:

DOL = MP/EBIT = ((p-v)*Q)/((p-v)*Q-FC)

where MP is marginal profit;

EBIT - earnings before interest;

FC - semi-fixed production costs;

Q - production volume in physical terms;

p - price per unit of production;

v - variable costs per unit of production.

Level operating leverage allows you to calculate the percentage change in profit depending on the dynamics of sales volume 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 therefore, the greater the business (production) risk.

As revenue moves away from the break-even point, the power of operating leverage decreases, and the organization’s margin of financial strength, on the contrary, increases. This Feedback associated with a relative reduction in the enterprise’s fixed costs.

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 is sales revenue; VC - variable costs.

Level operating leverage is not a constant value and depends on a certain, basic implementation value. For example, with a break-even sales volume, the level of operating leverage will tend to infinity. Operating leverage is greatest at a point slightly above the break-even point. In this case, even a slight change in sales volume leads to a significant relative change in EBIT. The change from zero profit to any profit represents an infinite percentage increase.

In practice, greater operating leverage is possessed by those companies that have a large share of fixed assets and intangible assets (intangible assets) in the balance sheet structure and large management expenses. Conversely, the minimum level of operating leverage is inherent in companies that have a large share of variable costs.

Thus, understanding the mechanism of production leverage allows you to effectively manage the ratio of fixed and variable costs in order to increase profitability operational activities companies.

The ratio of costs for a given sales volume, one of the measurement options of which is the ratio of marginal income to profit, is called operating leverage . This indicator is “quantitatively characterized by the ratio between fixed and variable expenses in their total amount and the variability of the indicator “earnings before interest and taxes” . It is higher in those companies in which the ratio of fixed costs to variable costs is higher, and correspondingly lower in the opposite case.

The operating leverage indicator allows you to quickly (without preparing a full income statement) determine how changes in sales volume will affect the company's profit. To find out by what percentage the profit margin will change, the percentage change in sales volume should be multiplied by the level of operating leverage.

One of the main tasks of analyzing the cost-volume-profit relationship is to select the most profitable combinations of variable and fixed costs, selling prices and sales volumes. The amount 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, making these decisions does not require drawing up a new profit and loss 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 must be clear about the following:

- firstly, a change in fixed costs changes the position of the break-even point, but does not change the size of the marginal income.
- secondly, a change in variable costs per unit of production 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.
- fourthly, a change in the selling price changes the contribution margin and the location of the break-even point.

In practical calculations, to determine the strength of operating leverage, the ratio of gross margin to profit is used:

Operating leverage measures how much profit will change if revenue changes by one percent. Thus, by setting a particular rate of growth in sales volume (revenue), it is possible to determine the extent to which the amount of profit will increase given the existing strength of operating leverage at the enterprise. Differences in the achieved effect 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 comes down to changing the value of the strength of the operating leverage under different trends in the commodity market conditions and stages life cycle enterprises.

In case of unfavorable conditions on the product market, as well as in the early stages of the enterprise’s life cycle, its policy should be aimed at reducing the strength of operating leverage by saving on fixed costs. Under favorable market conditions and in the presence of a certain margin of safety, the requirement for implementing a regime for saving fixed costs can be significantly weakened. During such periods, an enterprise can expand the volume of real investments by modernizing its main 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 constant savings.

The margin of financial strength is the edge of an enterprise's security. The calculation of this indicator allows us to assess the possibility of an additional reduction in revenue from product sales within the break-even point. Therefore, the margin of financial strength is nothing more than the difference between sales revenue and the profitability threshold. The margin of financial strength is measured either in in monetary terms, or as a percentage of revenue from product sales:

So, the strength of operating leverage 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 “weights down” fixed costs is the increase in the effect of “financial leverage” with an increase in loan interest in the capital structure. In turn, operating leverage generates stronger profit growth compared to growth in product sales (revenue), increasing earnings per share and thereby increasing the power of financial leverage. Thus, financial and operating levers are closely related, mutually reinforcing each other.

Definition

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

High or low operating leverage

A low value of the operating leverage ratio indicates the predominant share of variable expenses in the company's total expenses. 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. All other things being equal, such companies are more stable and less sensitive to changes in sales volume.

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

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

Formula

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

IN general view 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 value of marginal profit ( English Contribution Margin).

This formula can be transformed as follows.

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

Also, operating leverage can be calculated as the ratio of the marginal profit ratio ( English Contribution Margin Ratio) to the coefficient operating profitability (English Operating Margin Ratio).

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

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

Calculation example

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

Company A

Percentage change in operating income +20%
Percentage change in sales revenue +16%

Company B

Revenue from sales: 5 million cu.
Total variable expenses CU 2.5 million
Fixed expenses 1 million cu.

Company B

Revenue from sales: 7.5 million USD
Total marginal profit 4 million.u.
Operating profitability ratio 0.2

The operating leverage ratio for each company will be as follows:

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

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

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

As you can see in the graph, Company B is most vulnerable to a decline in sales, while Company A will be the most resilient. On the contrary, with an increase in sales volume, Company B will demonstrate the most high rates operating income growth, and Company A – the lowest.

conclusions

As mentioned above, companies with high operating leverage ratios are vulnerable to even minor declines in sales. In other words, a decline in sales of a few percent could result in the loss of a significant portion 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 higher potential for operating income growth.

The goal of any commercial enterprise is the maximum profit resulting from economic activity. To assess the effectiveness of management, the rationality of measures, a comparison is required, and by calculating the operating leverage.

Operating leverage

An indicator that reflects the degree of change in the rate of profit over the rate of change in revenue as a result of the sale of goods or services.

Features of the operating lever

A positive effect is observed only when the break-even point is overcome, when all costs are covered and the company increases profitability as a result of its activities.
With the growth of sales volume, the operating leverage decreases, because. with an increase in the number of goods sold, the amount of profit growth becomes larger, and vice versa, with a decrease in the volume of goods sold, the operating leverage is higher. Enterprise profit and operating leverage are inversely related.
The effect of operating leverage is reflected only over a short period of time. Since fixed costs remain unchanged only in a short period.

Types of operating leverage

price– determines the price risk, i.e. its impact on the amount of profit from sales;
natural– allows you to assess the risk of production, how production volumes affect the profit indicator.

Measures of operating leverage

share of fixed costs;
the ratio of profit before taxes to the rate of output in physical terms;
the ratio of net income to fixed costs of the company.

Leverage Formula

P = (B − Trans) (B − Trans - Post) = (B − Trans) P P=(B-\text(Trans))(B-\text(Trans)-\text(Post))=(B -\text(Per))\text(P)P=(B −Per) (B −Per− Fast) = (B −Per) P,

Where B B B- the amount of proceeds from the sale of goods,

Per \text(Per) Per– variable expenses,

Post \text(Post) Fast– costs are constant,

P\text(P) P- profit from activities.

Examples of problem solving

Example 1

Determine the amount of operating leverage if in the reporting period the company has revenue in the amount of 400 thousand rubles, variable costs 120 thousand rubles, fixed costs 150 thousand rubles.

Solution

According to the operating leverage formula
P = 400 − 120400 − 120 − 150 = 2.15 P = 400-120400-120-150 = 2.15P=4 0 0 − 1 2 0 4 0 0 − 1 2 0 − 1 5 0 = 2 , 1 5

Answer: Operating leverage is 2.15.

Conclusion: For every ruble of profit there is 2.15 rubles. marginal revenue.

Example 2

The company's variable costs last year were 450 thousand rubles, this year they are 520 thousand rubles. How much has the revenue changed if the profit last year was 200 thousand rubles, this year is 250 thousand rubles, and the operating leverage, which has a level of 1.85, decreased by 30% this year?

Solution

Let's compose the operating leverage equations for two periods:

P 1 = (B 1 − 450) 200 = 1.85 P1 = (B1-450) 200 = 1.85P 1 =(B 1 −4 5 0 ) 2 0 0 = 1 , 8 5

P 0 = (2 − 520) 250 = 1, 85 ⋅ (1 − 0, 30) P0=(2-520)250=1.85\cdot(1-0.30)P 0 =(2 − 5 2 0 ) 2 5 0 = 1 , 8 5 ⋅ (1 − 0 , 3 0 )

B 1 = 1.85 ⋅ 200 + 450 = 820 B1=1.85\cdot200+450=820B 1 =1 , 8 5 ⋅ 2 0 0 + 4 5 0 = 8 2 0 thousand roubles.

B 2 = 1.85 ⋅ 0.70 ⋅ 250 + 520 = 843.75 B2=1.85\cdot0.70\cdot250+520=843.75B 2 =1 , 8 5 ⋅ 0 , 7 0 ⋅ 2 5 0 + 5 2 0 = 8 4 3 , 7 5 thousand roubles.

Change in revenue: 843750 − 820000 = 23750 843750-820000 = 23750 8 4 3 7 5 0 − 8 2 0 0 0 0 = 2 3 7 5 0 rub.

Answer: Revenue changed to 23,750 rubles.

Thus, the operating leverage is greater, the lower the variable costs of the enterprise and the higher the share of fixed costs. To reduce risk commercial activities it is necessary to strive for a lower value of operating leverage.