Operating leverage can be less than 1. Operating leverage (operating leverage) and the method for calculating it

AND . The influence of this ratio on the amount of profit from sales of products can be traced from the figure.

Graph of the dependence of the amount of profit on the ratio of constants and variable costs

The figure shows two enterprises that, with the same volume of achieved sales of products ( R f) have the same amount of costs (current costs) and the same amount of net income. However, enterprise A has a ratio of fixed and variable costs of 2:1, and enterprise B has a ratio of 1:2, respectively. Due to the existing operating leverage (high share fixed costs in their total amount) enterprise A much later reaches the break-even point when selling products ( R TB), i.e. To reach this point, he needs to sell a much larger volume of products than enterprise B.

At the same time, with a further increase in the volume of product sales (after overcoming ), enterprise A will receive a larger amount of profit per unit of increase in production than enterprise B. This is due to the fact that due to fixed costs, their overall level in relation to the volume of product sales and net income at enterprise A will decrease by to a greater extent(thereby increasing, all other things being equal, the amount).

Operating leverage (operating leverage, production leverage) is the ratio of a company's fixed and variable expenses and the impact of this ratio on operating profit, that is, earnings before interest and taxes. If the share fixed costs is large, then the company has a high level of production leverage, while a small change in production volumes can lead to a significant change in operating profit.

The use of operating leverage allows you to manage future sales profits of an enterprise by planning future revenue. The main factors that influence revenue volume are:

• product price;
• variable costs;
• fixed costs.

Therefore, the goal of management becomes the optimization of variables and fixed costs, regulation pricing policy to increase sales profits.

Price operating leverage is calculated using the formula:

Where
IN- sales revenue;
P- revenue from sales;
Z lane- variable costs;
3 post- fixed costs;
R c- price operating leverage;
R n- natural operating leverage.

Natural operating leverage is calculated using the formula:

Considering that B = P + Z lane + Z post, we can write:

Operating leverage is used by managers to balance various types of costs and, accordingly, increase income.

Operating leverage makes it possible to increase profits when the ratio of variable and fixed costs changes.

Problems that are solved using operational leverage:

1. 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;
2. determining the production critical point and using it in acceptance management decisions and setting prices for work;
3. making decisions on additional orders (answering the question: will an additional order lead to an increase in fixed costs?);
4. making a decision to stop producing goods or providing services (if the price falls below the level variable costs);
5. solving the problem of maximizing profits through a relative reduction in fixed costs;
6. using a threshold when developing production programs, setting prices for goods, work or services.

In the economic literature, the concept of “leverage” (operational and financial) is often encountered.

Definition

Thus, production leverage is represented by the ratio of variable and fixed costs of the enterprise, which influences is determined without taking into account taxes and interest.

With a significant amount of fixed costs, a business entity is characterized by high-level operating leverage, which leads to small changes in production volumes to significant changes in operating profit.

In other words, the effect of such production leverage also manifests itself in generating strong changes in profits with any changes in sales revenue.

It is not without reason that along with the term “leverage”, this article uses its synonym – “leverage”. Indeed, translated from English, leverage means “lever.”

Thus, production leverage (operational leverage is another name for it) is a mechanism for effective profit management any business entity that is based on improving the ratio of variable and fixed costs. Using this indicator, it becomes possible to plan any changes in profit at the enterprise depending on changes in sales volumes. In this case, the break-even point can be calculated.

Cost classification

A necessary condition under which operating leverage can be used is the use of the marginal method, based on dividing all expenses into variable and constant.

Thus, the higher the share of fixed costs in the total costs of a business entity, the less the profit margin will change in relation to the rate of change in the enterprise’s revenue.

Returning to the classification of expenses, it should be noted that their level (for example, in a company’s revenue has a significant impact on the trend of changes in costs or profits. This is due to the fact that additional profitability, which goes to cover fixed costs, is generated from an additional unit of production. When this is the increase in total income from such an additional unit finished products(or product) is expressed in a change in the amount of profit. When the break-even level is reached, profit is formed, which is characterized by faster growth than

Operating leverage effect

This serves as a fairly effective tool in determining and analyzing the above dependence. In other words, its main purpose is to establish the impact of profit on any changes in sales volumes.

The essence of its action is that an increase in revenue contributes to a greater increase in the amount of profit. However, this may be limited in terms of variable and fixed costs. Economists have proven that the higher the share of fixed costs, the higher its limitation.

Industrial leverage (operating) in quantitative terms is characterized by a comparison of fixed and variable costs in their total amount with the value of such an economic indicator as earnings before interest and taxes. The following price and natural are known.

By calculating production operating leverage, it is possible to predict with sufficient accuracy any change in profit with various changes in the amount of revenue.

To better understand this economic indicator, it is necessary to consider the procedure for its calculation.

Operating leverage

The formula for calculating production leverage is quite simple: the ratio of revenue and profit from sales.

Considering revenue as the sum of both constants and profits, you can understand that the formula for calculating operating leverage will take the following form:

Ol = (Pr + Rper + Rpost)/Pr = 1 + Rper/Pr + Rpost/Pr.

Operating leverage is not assessed as a percentage, since this indicator is represented by the ratio of marginal income to profit. Due to the fact that in addition to profit, there is also the amount of fixed costs, the value of the production lever is always above one.

Operating leverage as an indicator of enterprise performance

The value of this indicator is considered to reflect the riskiness of not only the business entity itself, but also the type of business in which it is engaged. This is due to the fact that the ratio of expenses in the structure of all costs is a reflection not only of the characteristics of the enterprise with its accounting policies, but also of individual industry characteristics of its economic activities.

Economists have proven that the high level of fixed costs in general structure costs of a business entity is not always a negative phenomenon. This is due to the fact that it is impossible to simply absolute the amount of marginal income. An increasing level of operating leverage shows an increase in the company's overall production capacity, technical re-equipment, and increased labor productivity. Profit of a business entity from high level production leverage is too sensitive to any changes in the value of revenue. With a sharp drop in sales, this enterprise quickly “falls” below the break-even limit. In other words, an enterprise with a very high leverage value is quite risky.

Characteristics of other types of economic levers

In the economic literature one can find the simultaneous use of such indicators as operating and financial leverage. Moreover, if operating leverage characterizes the dynamics of profit depending on changes in the amount of revenue of the enterprise, then financial leverage already characterizes changes in the value of profit minus interest payments on loans and credits in response to changes in operating profit.

There is another economic indicator - total leverage, which combines operating and financial leverage and shows how (by how many percentage points) the change in earnings after interest will occur for a one percent change in revenue.

Credit (financial) leverage

This economic indicator represents the ratio of the enterprise's own and borrowed capital, as well as its impact on profit.

With an increase in the share of borrowed capital, the value of net profit decreases. This is due to rising interest costs on loans.

The ratio of debt to equity shows the level of risk (financial stability). A highly leveraged enterprise is a financially dependent company. If the company finances its own economic activity only at the expense of its own capital, then it can be classified as a financially independent company.

Payment for the use of borrowed capital is often lower than the profit that it additionally provides. The specified additional profit can be summed up with the profit obtained using equity capital, which helps to increase the profitability ratio.

Problems to be solved

To fully analyze this economic indicator, it is necessary to list the tasks solved with the help of this operating leverage:

• both for the enterprise as a whole and for certain species products using the “expenses - volumes - profit” scheme;
• calculation of the critical production point using it when making certain management decisions, as well as establishing the cost of work;
• making decisions on the execution of additional orders and considering them for possible increases in costs in terms of fixed costs;
• consideration of the issue of discontinuing the production of certain types of goods when prices fall below the level of variable costs;
• maximizing profits due to a relative reduction in fixed costs;
• using the level of profitability with the development of production programs, setting prices for goods.

Conclusion

To summarize, it should be noted that operating leverage can be increased by raising borrowed funds. And very high production leverage can be leveled using financial leverage. Such effective economic instruments discussed in this article help the enterprise achieve the required return on investment while controlling the level of risk.

Financial leverage characterizes the enterprise's use of borrowed funds, which affect the measurement of the return on equity ratio. Financial leverage is an objective factor that arises with the appearance of borrowed funds in the amount of capital used by an enterprise, allowing it to obtain additional profit on its own capital. The formation of financial leverage is presented in "Fig 1":

“Fig.1.

Structure of formation of financial leverage" The greater the relative volume of borrowed funds attracted by the enterprise, the more amount interest paid on them, and the higher the level financial leverage

.

Consequently, this indicator also allows you to estimate how many times the enterprise's gross income (from which interest on the loan is paid) exceeds taxable profit.

Financial leverage allows us to distinguish three main components:

1. Tax adjuster of financial leverage (1-Snp), which shows to what extent the effect of financial leverage is manifested in connection with different levels of profit taxation. The tax corrector can be used in the following cases: a) if according to

various types

activities of the enterprise, differentiated rates of profit taxation have been established; b) if the enterprise uses tax benefits on profits for certain types of activities; c) if separate

subsidiaries

enterprises operate in free economic zones of their country, where preferential profit taxation regimes apply; d) if individual subsidiaries of the enterprise operate in countries with a lower level of income taxation 2. Financial leverage differential (KVRa-PC), which characterizes the difference between the gross return on assets ratio and the average interest rate on a loan. The financial leverage differential is

3. Financial leverage ratio (LC/SC), which characterizes the amount of borrowed capital used by the enterprise per unit of equity capital. The financial leverage ratio is the lever (leverage in literal translation - leverage) that causes a positive or negative effect obtained due to its corresponding differential.

With a positive differential value, any increase in the financial leverage ratio will cause an even greater increase in the return on equity ratio, and with a negative differential value, an increase in the financial leverage ratio will lead to an even greater rate of decline in the return on equity ratio. In other words, an increase in the financial leverage ratio causes an even greater increase in its effect. Thus, with a constant differential, the financial leverage ratio is the main generator of both the increase in the amount and level of profit on equity, and the financial risk of losing this profit. Similarly, with a constant financial leverage ratio, the positive or negative dynamics of its differential generates both an increase in the amount and level of return on equity, and financial risk

her loss.

- Calculation of financial leverage of an enterprise

Financial leverage is calculated as the ratio of the entire advanced capital of the enterprise to the equity capital:

Kfz = ZK/SK, (3.5)

i.e., it characterizes the ratio between debt and equity capital. This indicator is one of the most important, since it is associated with the choice of the optimal structure of sources of funds

An indicator reflecting the level of additionally generated profit on equity capital at different shares of borrowed funds is called the effect of financial leverage. It is calculated using the following formula:

EFL = (1 - Snp) x (KVRa - PK) x ZK/SK, (3.6) where EFL is the effect of financial leverage, which consists in an increase in the return on equity ratio, %; SNP - income tax rate, expressed as a decimal fraction; KVRa - gross return on assets ratio (ratio of gross profit to average cost assets), %; PC - the average size

- Operating leverage

Operational (production) leverage depends on the structure of production costs and, in particular, on the ratio of semi-fixed and semi-variable costs in the cost structure.

Therefore, production leverage characterizes the relationship between the cost structure, output volume and sales and profit. Production leverage shows the change in profit depending on changes in sales volumes.

The concept of operating leverage is associated with the cost structure and, in particular, with the relationship between semi-fixed and semi-variable costs.

- Consideration of the cost structure in this aspect allows, firstly, to solve the problem of profit maximization due to the relative reduction of certain expenses with an increase in the physical volume of sales, and, secondly, dividing costs into conditionally constant and conditionally variable allows us to judge the payback costs and provides the opportunity to calculate the margin of financial strength of the enterprise in case of difficulties, complications in the market, thirdly, it makes it possible to calculate the critical sales volume that covers costs and ensures break-even activity of the enterprise.

Solving these problems allows us to come to the following conclusion: if an enterprise creates a certain amount of semi-fixed expenses, then any change in sales revenue generates an even stronger change in profit. This phenomenon is called the operating leverage effect.

Calculations of the operating leverage ratio and the effect of operating leverage

The operating leverage ratio shows the strength of the operating leverage. It is calculated using the following formula:

Col = I post / I o (3.7)

Where And post is the sum of fixed operating costs. And o is the total amount of operating costs.

The effect of production leverage is that a change in sales revenue always leads to a larger change in profit. The strength of operating leverage is a measure of the business risk associated with the enterprise. The higher it is, the greater the risk shareholders bear;

profitability threshold. This is the volume of sales revenue at which zero profit is achieved with zero losses.

The effect is calculated using the following formula: Eol = ΔBOP / ΔOP, (3.8)

The main goal of developing a dividend policy is to establish the necessary proportionality between the current consumption of profit by the owners and its future growth, maximizing the market value of the enterprise and ensuring its strategic development.

Based on this goal, the concept of dividend policy can be formulated as follows: dividend policy is an integral part of the overall profit management policy, which consists in optimizing the proportions between its consumed and capitalized parts in order to maximize the market value of the enterprise.

- Characteristics of the types and approaches of the enterprise's dividend policy.

There are three approaches to the formation of dividend policy - “conservative”, “moderate” (“compromise”) and “aggressive”.

Each of these approaches corresponds to a certain type of dividend policy. 1. Residual dividend policy

assumes that the dividend payment fund is formed after the need for the formation of its own financial resources, ensuring the full implementation of the enterprise’s investment opportunities, is satisfied at the expense of profits. 2. Policy of stable dividend payments

3involves payment of a constant amount over a long period (at high rates of inflation, the amount of dividend payments is adjusted to the inflation index)..

4. Minimum stable dividend policy with a premium in certain periods (or the “extra-dividend” policy), according to a very widespread opinion, represents its most balanced type.

5. Stable dividend policy provides for the establishment of a long-term standard ratio of dividend payments in relation to the amount of profit. The advantage of this policy is the simplicity of its formation and the close connection with the amount of profit generated"

Finally, measures are developed aimed at increasing the dividend return of share capital. These are mainly activities that help increase net profit and return on equity.

- Financial mechanism management of the formation of operating profit.

The mechanism for managing the formation of operating profit is built taking into account the close relationship of this indicator with the volume of product sales, income and costs of the enterprise. The system of this relationship, called the “Interrelationship of costs, sales volume and profit,” allows us to highlight the role of individual factors in the formation of operating profit and ensure effective management of this process in the enterprise.

In the process of managing the formation of operating profit based on the CVP system, the enterprise solves the following tasks:

1. Determination of the volume of product sales that ensures break-even operating activities for a short period.

2. Determination of the volume of product sales that ensures break-even operating activities in the long term.

3. Determining the required volume of product sales to ensure the achievement of the planned amount of gross operating profit. This problem can also have an inverse formulation: determining the planned amount of gross operating profit for a given planned volume of product sales.

4. Determination of the amount of the “safety limit” of the enterprise, i.e. the size of a possible reduction in product sales.

5. Determining the required volume of product sales to ensure the achievement of the planned (target) amount of marginal operating profit of the enterprise.

- The main goal of managing the formation of operating profit

The main goal of managing the formation of an enterprise's operating profit is to identify the main factors that determine its final size and to find reserves for further increasing its amount.

The mechanism for managing the formation of operating profit is built taking into account the close relationship of this indicator with the volume of product sales, income and costs of the corporation. The system of this relationship, called “The relationship between costs, sales volume and profit" allows you to highlight the role individual factors in the formation of operating profit and ensure effective management of this process at the enterprise.

Receiving gross income from product sales. The main source of profit from sales is gross income from the sale of goods. Gross income equal to the sum trade allowances.

Gross income consists of the amount Money received from the sale of goods, due to the difference between the sale price of goods and the price of their acquisition. This portion of gross income represents the trade markup.

TO the most important factors, forming the volume and level of gross income, include

Volume, composition and assortment structure of trade turnover;

Terms of delivery of goods;

Economic feasibility of trade markup;

Quantity and quality of additional services.

An increase in the volume of trade turnover means an increase in the amount of gross income: the more goods sold, the greater the total amount of funds received from the trade markup. The market model of the economy allows trading enterprises independently set premiums for most product groups. It is only important to find a certain line in order, on the one hand, to prevent losses in income, and on the other, to maintain competitive prices.

A qualitative indicator of gross income from sales is the level of gross income: Amount of gross income = amount of trade markups

ATC = (Sum of ATC / To) * 100% (3.9)

The level of gross income shows the amount of income per ruble of trade turnover.

Net income from product sales. Net income from product sales is determined by subtracting relevant taxes, fees, discounts, etc. from income (revenue) from product sales.

The net income indicator is calculated using the formula, where the numerator is the sum of depreciation volumes of fixed assets and intangible assets plus net profit, the denominator is net revenue from product sales plus income from other sales and income from non-sales operations.

Calculation of marginal operating profit. Marginal operating profit is the result of net operating income (i.e. excluding VAT) without fixed costs, its calculation is carried out using the following formula:

MOP=CHOD-Ipost;

(3.10)

Where, VOD is the amount of net operating income in the period under review; Ipost is the sum of fixed operating costs. Calculation of gross operating profit.

Gross operating profit is calculated using the following formula:

VOP=CHOD-Io;

Calculation of net operating profit. Net operating profit is income after taxes, it is also called after-tax operating profit (Net Operating Profit Less Adjusted Tax, NOPLAT). Net operating income does not take into account the fact that a business must cover both operating costs and capital expenditures.

Net operating profit, its calculation is carried out using the following formulas:

CHOP+CHOD-IO-NP;

CHOP=MOP-Iper-NP; CHOP=VOP-NP; (3.12)

Where NP is the amount of income tax and other mandatory payments from profits.

Financial leverage is the ratio of a company's borrowed capital to its own budget. Thanks to it, you can study the financial position of the company, the degree of risk of failure of the enterprise or the likelihood of its success. The lower the leverage ratio, the more stable the company's position. But do not forget that with the help of a loan, many small businesses grow into larger ones, and large ones, having received additional profit to their own capital, improve their situation.

Purpose of financial leverage

Financial leverage in economics can be called credit leverage, leverage, financial leverage, but the meaning does not change. A lever in physics helps to lift heavier objects with less effort, and the same in economics. The financial leverage ratio allows you to get greater profits. It takes less effort and time to make your dreams come true. Sometimes you can find the following definition: “Financial leverage is an increase in the profitability of an enterprise’s personal income due to the use of borrowed funds.”
Changing the capital structure of an enterprise (shares of equity and borrowed funds) allows you to increase the company's net profit. As a rule, additional capital received as a result of leverage is used to create new assets, improve company productivity, expand branches, etc. How more money
rotates within the enterprise, the more expensive cooperation with owners is for investors and shareholders, and this, undoubtedly, plays into the hands of general directors.

Based on the concept of leverage, it can be argued that the effect of financial leverage is the ratio of borrowed capital to own profit, expressed as a percentage.

Who needs to know what leverage is and why? It is important not only for investors and lenders to understand and be able to evaluate the structure. However, for an investor or banker, the amount of leverage serves as an excellent guide for further cooperation with the enterprise and the size of lending rates.

To the entrepreneurs themselves, company owners, financial managers it is necessary to know the structure of leverage and be able to evaluate it to understand financial condition company and dependence on external loans. If inexperienced entrepreneurs neglect knowledge of leverage, they can easily lose financial independence due to large loans and external debts. If the directors decide that the company is developing well even without a credit history, then they will miss the opportunity to increase the return on assets, and, therefore, will slow down the process of the company’s rise on the “career ladder.”
External loans make it possible to increase a company's productivity faster and more efficiently, but they can also draw it into economic dependence on loans.

It is also worth remembering that an entrepreneur should never take unjustified loans (unnecessary for a given stage of the company’s development). When applying for a loan, you must accurately understand the amount of funds needed to expand your business or increase sales.

Formula for financial leverage.

There are many nuances in economics, without knowing which, beginners easily fall for credit tricks and fail to achieve their goals, blaming financial leverage for everything. Its formula should be firmly rooted in the brains of both business beginners and professionals.

EGF = (1 - Сн) x D x FR
EFR - effect of financial leverage;
Сн - direct tax on the profit of the organization, expressed in decimal(may vary depending on the type of activity of the enterprise);
D - differential, the difference between the profitability ratio (ROR) of assets and the percentage of the loan rate;
FR - financial leverage, the ratio of the average borrowed capital of an enterprise to the value of its own.

Patterns of leverage

In accordance with the formula, several patterns of leverage can be derived.

The differential must always be positive. This is an important impulse for the action of credit leverage, which allows the borrower to understand the degree of risk of the loan large sums entrepreneur. The higher the indicator, the less risk for a banker.
The shoulder (LR) also contains fundamentally important information for both participants in the process. The higher it is, the higher the risk for both the banker and the entrepreneur.
Based on these two aspects, it is obvious how leverage helps improve profitability. Financial leverage serves to increase not only one’s own profits, but also to determine the amount of credit that an entrepreneur can attract.

Average leverage ratio

Using practical methods, the optimal value of the financial leverage indicator was determined (in percentage). For the average enterprise, the debt-to-equity ratio ranges from 50 to 70%. If this indicator decreases by at least 10%, the entrepreneur’s chance to develop his company and achieve success is lost, and if it increases to 80 or 90%, the financial independence of the entire enterprise is put at great risk.
However, we should not forget that the normal level of leverage depends on the industry, scale (size of business, number of branches, etc.) and even on the method of organizing management and approach to building the company structure.

Main components of financial leverage

Financial leverage largely depends on secondary factors. Each of them needs to be disassembled separately. Financial leverage indicator equal to the ratio loan capital to equity capital. Consequently, the factor that changes the indicator of the leverage effect in the first place is return on assets, that is, the ratio of the net profit of the enterprise (for the year) to the value of all assets (the balance of the enterprise).

Financial leverage ratio - leverage, showing what share in the overall structure of the company is occupied by borrowed or other funds required to be repaid (loans, courts, etc.). Using leverage, the power of influence on the net profit of borrowed funds is determined.

Why do you need a tax corrector?

When using financial leverage in calculations, experienced economists refer to such a definition as a tax adjuster. Thanks to it, you can find out how the effect of financial leverage changes when income taxes increase or decrease. Let us remember that everyone pays income tax. legal entities RF (OJSC, CJSC, etc.), and its rate is different and depends on the type of activity and the amount of real income. So, the tax corrector is used only in three cases:

1. If there are different tax rates;
2. If the enterprise uses benefits (for certain types of activities);
3. If subsidiaries(branches) are located in free economic zones of the state where there is preferential treatment or branches are located in foreign countries with the same zones.

Thus, when the tax burden is reduced for one of these reasons, the dependence of the effect of financial leverage on the adjuster is noticeably reduced.

Operating leverage

Operating and financial leverage in the stock market keep pace. The first indicator indicates changes in the growth rate of sales profit. If you know what operating leverage is, you can accurately predict the change in profit for the year when your monthly revenue changes.

In the market, there is the concept of a break-even point, which shows the amount of income needed to cover expenses. At this point, if you display it on the coordinate line, the net profit is zero, the left side is negative (the company incurs losses), the right side is positive (the company covers expenses and net profit remains). This straight line is called an indicator of the financial strength of the company.

Operating leverage effect

The strength with which the operating lever operates in an enterprise depends on the average weight of fixed costs in the total cost of costs (fixed and variable). Thus, the production leverage effect is the most important indicator of an enterprise’s budget risk, calculated using the following formula:

• EOR = (Fibreboard+PR)/Fibreboard
• EOR - effect of operating leverage;
• EBI - income before interest (taxes and debts);
• PR - fixed production costs (the indicator does not depend on revenue).

Why does the effectiveness of financial leverage decrease?

The financial leverage of an enterprise certainly shows how competently the owner handles his own and borrowed funds, but risk always exists, especially if there are problems with economic situation On the market. So what factors reduce the effectiveness of financial leverage and why does this happen?

When the financial situation in the market worsens, the cost of borrowing sharply increases, which will certainly affect the indicator of financial leverage depending on the entrepreneur’s choice: take out a loan at new rates or use his own income.

Decline financial stability companies due to the economic crisis or inept handling of money (constant loans, large expenses) leads to an increased risk of bankruptcy of the company. Interest rates for such people they increase, and, therefore, the indicator of financial leverage decreases. Sometimes it can go to zero or take a negative value.

A decrease in demand for a product leads to a decrease in income. This reduces the return on assets, and this factor is the most important in the formation of financial leverage.
It follows that the effectiveness of financial leverage decreases due to external factors(market conditions), and not through the fault of the entrepreneur or accountants.

Entrepreneurship - risk or delicate work?

Thus, financial leverage determines the most important indicator of the state of an enterprise in the economy, is calculated as the ratio of borrowed capital to equity and has a so-called average value of 50 to 70%, depending on the type of activity. However, many young entrepreneurs, due to their inexperience, do not attach due importance to leverage and do not notice how they become financially dependent on larger corporations or bankers.

That is why people who connect their lives with the economy and the stock market need to know all the subtleties, nuances and aspects of entrepreneurship.

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

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

As we know, there are two types of costs in an enterprise: variables and constants. Their structure as a whole, and in particular the level of fixed costs, in the total revenue of the enterprise or in revenue per unit of production can significantly influence the trend in profit 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 overall increase in income from an additional unit of goods can be expressed in a significant sharp change in profit. Once the break-even level is reached, profits appear and begin to grow faster than sales.

Operating leverage is a tool for determining and analyzing this relationship. In other words, it is intended to establish the impact of profit on changes in sales volume. The essence of its action is that with an increase in revenue, a greater growth rate of profit is observed, but this greater growth rate is limited by the ratio of fixed and variable costs. The lower the share of fixed costs, the lower this limitation will be.

Production (operating) leverage is quantitatively characterized by the ratio between fixed and variable expenses in their total amount and the value of the indicator “Earnings before interest and taxes”. Knowing the production lever, you can predict changes in profit when revenue changes. There are price levers and natural price levers.

Price operating (production) lever

Price operating leverage (Pc) is calculated using the formula:

Rc = V/P

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

Considering that V = P + Zper + Zpost, the formula for calculating price operating leverage can be written as:

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

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

Natural operating (production) leverage

Natural operating leverage (RN) is calculated using the formula:

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

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

Size 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 the overall cost structure is a reflection not only of the characteristics of this enterprise and its accounting policies, but also industry characteristics of its activities.

However, it is impossible to consider that a high share of fixed expenses in the cost structure of an enterprise is a negative factor, just as it is impossible 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 a business can very quickly “fall” below the break-even level. In other words, a company with a higher level of operational leverage is riskier.

Since operating leverage shows the change in operating profit in response to a change in the company's revenue, and financial leverage characterizes the change in pre-tax profit after paying interest on loans and borrowings in response to a change in operating profit, total leverage gives an idea of ​​how much percent the profit before taxes will change after interest is paid when revenue changes by 1%.

So small operating leverage can be strengthened by raising borrowed capital. High operating leverage, on the contrary, can be offset by low financial leverage. With the help of these effective tools - operational and financial leverage - an enterprise can achieve the desired return on invested capital at a controlled level of risk.

In conclusion, we list the tasks that are solved using 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;

determining the critical point of production and using it in making management decisions and setting prices for work;

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

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

solving the problem of maximizing profits through a relative reduction in fixed costs;

using the profitability threshold when developing production programs and setting prices for goods, work or services.