effect of operating leverage (production) - a rapid change in net profit during the growth of sales revenue.He is influenced by the fixed costs of the production process and sale.At the same time, these costs remain unchanged, while revenue grows.
strength of operating leverage shows how much interest there is a change in the profit increase (or decrease) in revenue by 1%.The higher proportion of expenditure (constant) used in the production and sales, the more powerful a lever.The formula of its definition: the difference between revenue and cost / benefit.
The definition of "leverage" is used in various sciences.This is a special device that allows you to increase the impact of this or that object.In economics, as such a mechanism are the fixed costs.Operating lever reveals how the company depends on the costs included in the cost of production.This indicator shows the business risk.
effect of operating leverage is observed in the fact that even a small change in revenue resulting in a strong increase or decrease in profits.We assume that the share of expenses in the permanent production costs high, then the company has a very high level of production of the lever.Consequently, a significant business risk.If such a venture even slightly change the volume of sales, will receive substantial profit swings.
The work of each organization has a break-even point.It the level of operating leverage tends to infinity.But with a slight deviation from the sales point of this happening is quite a significant change in profitability.And the greater the deviation from the break-even point, the smaller the income the company receives.It should be borne in mind that almost all of the company engaged in production or sale of several types of products.Therefore, the effect of operating leverage should be considered on the total sales revenue and each of goods (services) separately.
In the case where there is a growth of fixed costs, you need to choose a strategy aimed at increasing sales volumes.It does not matter even reducing variable costs.On the effect of operating leverage only affect fixed costs.It is important for the analysis of financial management.Study of operating leverage helps to choose the right strategy in the management of benefits, costs and business risk.
There are several factors affecting the level of production of the lever:
- the price at which products are sold;
- sales;
- costs, mainly permanent.
If there was an adverse market conditions, this leads to a decrease in sales.Typically, such a situation is the first step of the product life cycle.Then the break-even point has not been overcome.And it requires a significant reduction in fixed costs, calculation of financial leverage.Conversely, when market conditions are favorable, you can just relax control over costs.This period may be used for the modernization of fixed assets, for investment in new projects, purchases of assets, etc.
branch enterprise dictates certain requirements for the size of investments, automation of labor, to the training of specialists, etc.If an organization working in the field of mechanical engineering, heavy industry, the management of the operating lever is difficult.This is due to large fixed costs.But if the company is engaged in the provision of services, the regulation of the operating lever is quite simple.
Targeted control variable and fixed costs, changing them according to the current market situation will reduce business risk and increase the profits of the enterprise.
