- Operating lever
- financial leverage
operating lever -
Used indicators:
1.
2.
3. Margin of financial strength
A task:
financial leverage -
The effect of financial leverage
Funding rules:
financial planning
Financial planning -
Planning principles:
Planning methods:
- Normative.
Budgeting
Budgeting tasks:
- Sales budget.
- production budget.
- Budget business expenses.
- Forecast profit report.
The financial budget includes:
- Investment budget.
- Budget Money.
- Forecast balance.
Control financial risks
Essence and classification of financial risks
Ways to assess the degree of risk
Long-term and short-term financial policy of the enterprise
Long-term financial policy: investment and dividend
Fixed capital management
Economic nature, composition and structure of fixed capital
Principles and methods of fixed capital management
Financial indicators used for the analysis and evaluation of fixed capital
Capital planning
Depreciation of fixed capital
Methods for estimating the cost of fixed capital
Dividend policy of the company
Dividend Policy Models
Dividend policy - these are the principles for making decisions on the payment of a share of profits to shareholders in accordance with the share of their contribution to the total capital.
Dividend policy implementation options:
1. Cash dividends (the frequency of payment is essential here. Annual, semi-annual are common in Russia).
2. Payment of dividends by shares.
3. Splitting of shares (Split). If before the split they paid $ 1 per share, then after the split it is less.
4. Redemption by the firm of its shares.
Types of dividend policy:
1. Conservative (associated with the priority of capitalization of profits. There are two types of dividend policy: the residual policy of paying dividends and the policy of a stable amount of dividend payments).
2. Moderate (balancing the development of the company and the interests of the owners. There is a policy of the minimum stable amount of dividend payments with a premium of certain periods, that is, the policy of extra-dividends).
3. Aggressive (constant growth in dividend payments. A fixed percentage of the previous year is possible. The following types operate here: a policy of a stable level of dividends in relation to profit; a policy of constant increase in the size of dividend payments).
In Russia, dividends are paid on a residual basis. America has a conservative type of dividend policy.
The dividend policy includes the following elements (directions):
1. Choice of the type of dividend policy.
2. Choice of dividend payment procedure.
3. Determining the effectiveness of the dividend policy (current effects, long-term perspective).
An optimal dividend policy should strike a balance between current dividends and the company's future growth:
1. Dividend neutrality theory assumes that the dividend policy does not affect the company's share price and its value. The authors of the theory: Modeliani and Miller.
2. Gordon Model"A bird in the hand is worth two in the bush". According to the theory, the return on a stock is the sum of the current return, that is, on dividends and return on reinvestment.
3. Tax difference model is based on the fact that the mechanisms of taxation of current income and capital gains are different (if the profit is invested in production, then the income tax will be less).
The main patterns of formation of the dividend policy:
1. Most companies follow a strategy of setting a target payout ratio, that is, the ratio of dividends to net income or the level of payouts per share.
2. Dividends are a characteristic of the company's development prospects in the event of unforeseen changes.
3. The market reaction to negative signals (dividend reduction) is stronger than to positive ones (dividend growth).
4. There is a weak dependence of investor preferences in relation to the level of dividends (low-income investors prefer stocks with high dividends; rich investors, on the contrary, prefer stocks with low dividends).
Operational and financial leverage and
- Operating lever
- financial leverage
When evaluating the operational and financial leverage, the concept of "leverage" is used as a management tool.
Factors affecting profits are divided into production and financial. Therefore, the scope of the production (operational) and financial leverage is singled out.
operating lever - it is an opportunity to influence profit by changing the cost structure and output volume.
The operating leverage is based on the division of costs into conditionally fixed and conditionally variable.
To semi-fixed costs include costs that remain unchanged and the value of which does not depend on the growth or reduction in output.
To conditionally variable costs includes costs, the value of which depends on the production of products.
Used indicators:
1. Effect of operating leverage (impact force) - the ratio of the difference between revenue and variable costs to profit from sales.
The difference between revenue and variable expenses is called contribution margin (gross margin).
Features of the operating lever:
ESM depends on the structure of the assets of the enterprise (the greater the share of VNA, the greater the share of fixed costs);
High specific gravity fixed costs limits the ability to manage running costs;
The greater the impact of the OR, the higher the entrepreneurial risk.
2. Break-even point (profitability threshold) is defined as the ratio of fixed costs to the share of marginal income in total sales revenue.
3. Margin of financial strength equal to the difference between the sales proceeds and the threshold of profitability.
A task:
The proceeds from the sale of products amounted to 500 million rubles, semi-variable costs- 250 million rubles, conditionally permanent - 100 million rubles. Need to define ESM, TB and Financial Safety margin?
financial leverage - the ability to influence the profit of the enterprise by changing the volume and structure of long-term liabilities, that is, by changing the ratio of own and borrowed funds.
The effect of financial leverage is equal to the product of the differential (ROA - CZK) by the tax corrector (1 - Kn) and by the leverage of the financial leverage (ZK / SK). Where:
ROA - profitability of all capital (economic profitability);
CPC - price of borrowed capital (weighted average price of borrowed capital; average calculated interest rate for a loan);
Кн – tax coefficient (the ratio of the amount of taxes from profit to the amount of balance sheet profit; profit tax rate);
ZK - the average annual amount of borrowed capital;
SC - average annual amount equity.
Funding rules:
- If attracting additional borrowed funds gives a positive EGF, then such borrowing is profitable.
- With an increase in the leverage of financial leverage, an increase in the interest rate for a loan is possible, as lenders seek to compensate for the increased risk.
financial planning
- Financial planning in the system financial management
- Enterprise Budget and Budget Development Process
- Determining the need for additional funding
Financial planning - management of the process of creation, distribution and use of financial resources in the enterprise, which is implemented in detailed financial plans.
The main stages of the planning process:
- Analysis of investment and financing opportunities available to the company.
- Predicting the consequences of current decisions, that is, determining the relationship between current and future decisions.
- Justification of the developed option from several possible solutions.
- Evaluation of the results achieved by the company in comparison with the goals set in the financial plan.
Financial planning can be divided into long-term and short-term.
Long-term financial planning associated with the attraction of long-term sources of financing and is usually formalized in the form of an investment project.
Planning principles:
- The compliance principle is that the acquisition of current assets is planned mainly from short-term sources.
- The principle of constant need for own working capital.
- The principle of excess cash, that is, the company must have a certain reserve to cover current needs.
- When developing financial plans several planning methods are used.
Planning methods:
- Balance - determining the correspondence between income and expenses.
- Normative.
- Method of economic and mathematical modeling.
Budgeting- the process of planning the future activities of the enterprise, the results of which are formalized by the budget system.
Budgeting is usually carried out within the framework of operational planning, that is, based on strategic goals.
Budgeting tasks:
- Security ongoing planning.
- Ensuring coordination, cooperation and interrelationships in the division of the enterprise.
- Justification of the costs of the enterprise.
- Formation of a base for assessing and monitoring the implementation of enterprise plans.
Budgets are prepared for structural divisions and for the company as a whole. The budgets of departments are consolidated into a single budget of the enterprise.
The budgeting system can be divided into two parts:
1. Preparation of the operating budget.
2. Preparation of the financial budget.
The operating budget includes:
- Sales budget.
- production budget.
- Inventory budget.
- Budget for direct material costs.
- Production overhead budget.
- Budget for direct labor costs.
- Business expenses budget.
- Management budget.
- Forecast profit report.
The financial budget includes:
- Investment budget.
- Cash budget.
- Forecast balance.
The unit of reference is the month.
Determining the need for additional financing is the main task financial planning. When solving the problem, the following sequence of actions is possible:
- Formation of a forecast report on profit for the planned year.
- Preparation of the company's balance sheet for the planned year.
- Deciding on sources of additional funding.
- Analysis of the main financial indicators.
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 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. Other equal conditions, 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.
AT 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 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
AT reporting period companies showed 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's by 8.35% (1.67×5%), and Company C's 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.
Leverage (from the English leverage - the action of the lever).
Production (operating) leverage - the ratio of fixed and variable costs of the company and this ratio to the operating, that is, before interest and taxes. If the share of fixed costs is high, then the company has a high level of production leverage, while a small amount of production can lead to a significant change in operating profit.
The action of the operational (production, economic) lever is manifested in the fact that any change in sales proceeds always generates a stronger change in profit.
Production leverage effect (EPR):
EPR = VM / BP
VM - gross marginal income;
BP - balance sheet profit.
That. operating leverage shows how much the company's balance sheet profit changes when revenue changes by 1 percent.
The operating lever indicates the level of entrepreneurial risk of a given enterprise: the greater the impact of the production lever, the higher the degree of entrepreneurial risk.
Financial (credit) leverage - the ratio of borrowed capital and equity capital of the company and the impact of this ratio on net profit. The higher the share of borrowed capital, the lower the net profit, due to the increase in interest costs.
The ratio of debt to equity characterizes the degree of risk, financial stability. A highly leveraged company is called a financially dependent company. A company that finances its own with only its own capital is called a financially independent company.
The cost of borrowed capital is usually less than the additional profit it provides. This additional profit is added to the return on equity, which allows you to increase the profitability ratio. That. there is an increase in the return on equity, obtained through the use of credit, despite the payment of the latter.
It can only occur if the trader uses borrowed funds.
Effect of financial leverage (EFF), %:
EGF \u003d (1 - C N) * (R A - C ZK) * ZK / SK
where:
1 - C N - tax corrector
R A - C ZK - differential
ZK / SK - lever arm
C N - income tax rate, in decimal terms;
R A - return on assets (or return on assets ratio = the ratio of gross profit to average cost assets), %;
CZK - the price of borrowed capital of assets, or the average interest rate for a loan, %. (for a more accurate calculation, you can take the weighted average rate for the loan)
ZK - the average amount of borrowed capital used;
SC - the average amount of equity capital.
- 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.
- Ceteris paribus, greater financial leverage produces greater effect.
Associated lever. As the impact of operating and financial leverage increases simultaneously, less and less significant changes in the physical volume of sales and revenue lead to more and more large-scale changes in net profit. This thesis is expressed in the formula for the conjugate effect of operational and financial leverage:
P \u003d EGF * EPR
P is the level of the conjugated effect of operational and financial leverage.
The formula for the conjugate effect of production and financial leverage can be used to assess the total level of risk associated with the enterprise, and determine the role of entrepreneurial and financial risks in shaping the total level of risk.
Limitations of break-even analysis
Break-even analysis is a very useful tool at an early stage of decision-making when it is important to get an overall view of the business. However, you should keep in mind that this analysis is based on a number of assumptions that may not be true in every practical case. They are as follows:
All costs can be identified and classified as fixed or variable. In practice, this is not always possible, as unforeseen expenses may arise. So some types of costs are not easy to identify.
All variable costs are directly proportional to sales volume. However, in reality, costs can increase or decrease, for example, if one more worker is hired or a minimum amount of raw materials is purchased.
The range of goods is constant. Assumptions about a possible marriage and damage to the goods are not allowed. It is assumed that everything produced or purchased is sold. However, products are not always the same. Within each business transaction, they can undergo shrinkage, shrinkage, etc.
The whole system is in a stable state. The point is that break-even analysis cannot account for economies of scale. Initially, when New Product or the service is just “going into production”, it takes time for the staff to be fully trained, gain experience and start working more efficiently than at the beginning. This is the so-called productivity growth curve (i.e., the time to manufacture a unit of output is reduced), in this situation variable costs per unit of output change until production reaches full capacity and production system will not come to a state of stability.
The break-even analysis is based on cost and revenue projections. Despite the improvement in forecasting skills, there can always be unforeseen circumstances that significantly violate the forecast performance.
Ability to account for changes in costs and revenues through the application of sensitivity analysis, we more generally explore the possibility of accounting for uncertainty (unforeseen factors) in the future.
Let's imagine that Lyudmila's fitness club began to feel competition from Ruslan's gym. There were 20% fewer visitors than in the same month last year, when total number clients for the year amounted to 400. One of the ways to improve the situation is to make more efficient use of one of the rooms of the premises, which is now reserved for a pantry. This room can be subleased and receive 150 UAH. in Week.
An alternative course of action is to turn this room into a massage parlour, but this requires the employment of qualified personnel, annual expenses which will amount to UAH 9,000, and invest UAH 1,800. to additional equipment. It is expected that a fee of UAH 10 will be set for customers. for a half-hour massage session with a half-hour relaxation period after the massage. Variable costs will amount to 1.5 UAH. for one session.
The third alternative is to take part of the room under the pool. The experience of the best metropolitan sports clubs and gyms shows its popularity. The initial investment in this case will amount to UAH 30,000. for equipment (pool, steel floor reinforcement, decoration). The fee will be 20 UAH. per client per session lasting one hour. The cost of additional staff and cleaning will amount to 100 UAH. in Week. Variable costs are estimated at 2.5 UAH. from the client.
Using a break-even analysis, evaluate all these proposals and determine the most effective strategy option. Assume that new sports and recreation activities will continue 60 hours a week and 50 weeks a year. Equipment will be depreciated on a straight-line basis over six years, after which its residual value will be zero.
From an economic point of view, the above alternatives for doing business are distinguished by a different ratio of fixed and total variable costs (respectively, different break-even points, as well as different production and commercial opportunities). Economists say these options have different operating levers, which are determined different ratio fixed and variable costs at a given level of production (sales). Shoulder or operating lever level (URop) shows how many times the growth rate of operating profit exceeds the growth rate of sales volume at a given level of production volume and the ratio of fixed and variable costs.
This uses the formula:
where: MD- marginal income;
PROp– operating profit (before paying interest on loans and taxes).
In tables 1,2 and 3, as well as in fig. Figures 3 and 4 show two alternatives for the same business with low fixed costs (conservative) and high fixed costs (heavy operating leverage). Consider them in terms of profitability, break-even point and risk of possible losses.
The activities of almost any company are subject to risks. To achieve its goals, the company develops forward-looking financial indicators, including forecasts for revenue, cost, profit, etc. In addition, the company attracts financial resources to implement investment projects. Therefore, the owners expect that the assets will bring additional profit and provide a sufficient level of return on invested capital. (return on equity, ROE):
where NI (net income)- net profit; E (equity) is the equity capital of the company.
However, due to competition in the market, ups and downs of the economy, a situation arises when the actual values of revenue and other key indicators significantly different from those planned. This type risk is called operational (or production) risk (business risk), and it is associated with the uncertainty of obtaining operating income of the company due to changes in the situation on the sales market, falling prices for goods and services, as well as rising tariffs and tax payments. Great impact on production risks in modern economy leads to rapid obsolescence of products. Production risk leads to uncertainty in planning the profitability of the company's assets ( return on assets, ROA):
where A (assets)– assets; I (interests)- Percentage to be paid. In the absence of debt financing, the interest payable is zero, so the value ROA for a financially independent company is equal to the return on equity (ROE) and a company's production risk is determined by the standard deviation of its expected return on equity, or ROE.
One of the factors affecting the production risk of a company is share of fixed costs in its general operating expenses, which must be paid regardless of how much revenue its business generates. To measure the degree of influence of fixed costs on the company's profits, you can use the indicator of operating leverage, or leverage.
Operating lever (operating leverage) due to the company's fixed costs, as a result of which a change in revenue causes a disproportionate, stronger decrease or increase in the return on equity.
A high level of operating leverage is characteristic of capital-intensive industries (steel, oil, heavy engineering, forestry), which incur significant fixed costs, such as the maintenance and maintenance of buildings and premises, rental costs, fixed general production costs, utility bills, wage management personnel, property and land tax, etc. The peculiarity of fixed costs is that they remain unchanged and with the growth of production volumes, their value per unit of output decreases (the effect of scale of production). At the same time, variable costs increase in direct proportion to the growth of production, however, per unit of output, they are a constant value. To study the relationship between a company's sales volume, expenses and profit, a break-even analysis is carried out, which allows you to determine how much goods and services need to be sold in order to recover fixed and variable costs. This quantity of goods and services sold is called breakeven point (break-even point), and the calculations are carried out within break-even analysis (break-even analysis). The break-even point is the critical value of the volume of production, when the company is not yet making a profit, but is no longer incurring losses. If sales rise above this point, then a profit is formed. To determine the break-even point, first consider Fig. 9.4, which shows how the operating profit of the company is formed.
Rice. 9.4.
The break-even point is reached when the revenue covers operating expenses, i.e. operating profit is zero, EBIT= 0:
where R– selling price; Q- the number of units of production; V- variable costs per unit of production; F- total fixed operating costs.
where is the breakeven point.
Example 9.2. Suppose that the company "Charm", which produces cosmetic products, fixed costs are 3,000 rubles, the price of a unit of goods is 100 rubles, and variable costs are 60 rubles. per unit. What is the breakeven point?
Solution
We will carry out the calculations according to the formula (9.1):
In Example 9.2, we showed that the company needs to sell 75 units. products to cover their operating expenses. If you manage to sell more than 75 units. product, then its operating profit (and therefore, ROE in the absence of debt financing) will begin to grow, and if it is less, then its value will be negative. At the same time, as is clear from formula (9.1), the break-even point will be the higher, the greater the size of the company's fixed costs. A higher level of fixed costs requires more products to be sold in order for the company to start making a profit.
Example 9.3. It is necessary to conduct a break-even analysis for two companies, data for one of them - "Sharm" - we considered in example 9.2. The second company - "Style" - has higher fixed costs at the level of 6000 rubles, but its variable costs are lower and amount to 40 rubles. per unit, the price of products is 100 rubles. for a unit. The income tax rate is 25%. Companies do not use debt financing, so the assets of each company are equal to the value of their own capital, namely 15,000 rubles. It is required to calculate the break-even point for the company "Style", as well as to determine the value ROE for both companies with sales volumes of 0, 20, 50, 75, 100, 125, 150 units. products.
Solution
First, let's determine the break-even point for the Style company:
Let's calculate the value of the return on equity of companies for different sales volumes and present the data in Table. 9.1 and 9.2.
Table 9.1
Sharm company
|
Operating costs, rub. |
Net profit, rub., EBIT About -0,25) |
ROE, % NI/E |
|||
Table 9.2
Company "Style"
|
Operating costs, rub. |
Net profit, rub., EBIT (1 -0,25) |
ROE, % NI/E |
|||
Due to Style's higher fixed costs, the break-even point is reached at a higher sales volume, so the owners need to sell more products to make a profit. It is also important for us to look at the change in profit that occurs in response to a change in sales, for this we will build graphs (Fig. 9.5). As you can see, due to lower fixed costs, the break-even point for the company "Sharm" (chart 1) is lower than for the company "Style". For the first company, it is 75 units, and for the second - 100 units. After the company sells products in excess of the break-even point, revenue covers operating costs and additional profit is formed.
So, in the considered example, we have shown that in the case of a higher share of fixed costs in costs, the break-even point is reached with a larger volume of sales. After reaching the break-even point, the profit begins to grow, but as is clear from Fig. 9.4, in the case of higher fixed costs, profit grows faster for Style than for Charm. In the case of a decrease in activity, the same effect occurs, only a decrease in sales leads to the fact that losses grow faster for a company with higher fixed costs. Thus, fixed costs create a leverage that, with an increase or decrease in production, causes more significant changes profit or loss. As a result, the values ROE deviate more for companies with higher fixed costs, which increases risk. Using the calculation of the effect of operating leverage, you can determine how much the operating profit will change when the company's revenue changes. Operating leverage effect (degree of operating leverage, DOL) shows by what percentage the operating profit will increase / decrease if the company's revenue increases / decreases by 1%:
where EBIT- operating profit of the company; Q- sales volume in units of production.
At the same time, the higher the share of fixed costs in the company's total operating expenses, the higher the strength of the operating leverage. For a specific volume of production, the operating leverage is calculated by the formula
(9.2)
If the value of the operating leverage (leverage) is equal to 2, then with an increase in sales by 10%, operating profit will increase by 20%. But at the same time, if the sales revenue decreases by 10%, then the company's operating profit will also decrease more significantly - by 20%.
Rice. 9.5.
If the brackets are opened in formula (9.2), then the value QP will correspond to the company's revenue, and the value QV- total variable costs:
where S- the company's revenue; TVC- total variable costs; F- fixed costs.
If a company has a high level of fixed costs in general expenses, then the value of operating income will change significantly with revenue fluctuations, and there will also be a high dispersion of the return on equity compared to a company that produces similar products, but has a lower level of operating leverage.
The results of the company's activities largely depend on the market situation (changes in GDP, fluctuations in interest rates, inflation, changes in the exchange rate of the national currency, etc.). If the company is characterized by high operating leverage, then a significant proportion of fixed costs enhances the consequences of negative changes in the markets, increases the company's risks. Indeed, variable costs will decrease following the decline in production caused by market factors, but if fixed costs cannot be reduced, then profits will decline.
Is it possible to reduce the level of production risk of the company?
To some extent, companies can influence the level of their operating leverage by controlling the amount of fixed costs. When choosing investment projects, a company can calculate the break-even point and operating leverage for different investment plans. For example, trade company can analyze two sales options household appliances- in shopping malls or over the Internet. Obviously, the first option involves high fixed rental costs. trading floors, while the second trading option does not involve such costs. Therefore, in order to avoid high fixed costs and the risk associated with them, the company can provide a way to reduce them during the project development stage.
To reduce fixed costs, the company may also switch to subcontracts with suppliers and contractors. The experience of Japanese companies using subcontracting is widely known, in which a significant part of the production of components is transferred to subcontractors, the parent company concentrates on the most difficult technological processes, and fixed costs are reduced due to the withdrawal of individual capital-intensive industries to subcontractors. The Importance of Management fixed costs connected with the fact that their share has a great influence on the financial leverage, on the formation of the capital structure, which we will discuss in the next paragraph.