Profitability threshold what number is normal. What is the threshold of profitability? Examples and calculation formulas. In cash
Profitability threshold
Profitability threshold- this is such a proceeds from the sale, in which the enterprise covers its costs for the production and sale of products without making a profit and loss. Gross margin is only enough to cover fixed costs, and profit is zero.
More often, the profitability threshold is determined graphically.
Price - 0.5 thousand rubles. for 1 piece
Sales volume - 4,000 pcs.
Fixed costs - 550 thousand rubles.
Variable costs - 1,300 thousand rubles. (0.325 thousand rubles for 1 item)
Profit - 150 thousand rubles.
The order of plotting
where - fixed costs;
Percentage of gross margin to sales revenue.
In our example
thousand roubles. or
thousand roubles.
Number 3143m units. - the threshold quantity of goods. Each subsequent unit of goods will be profitable.
To determine the amount of profit after passing the threshold of profitability, it is enough to multiply the amount of goods sold in excess of the critical volume by the specific value of the gross margin in each unit of goods.
For example.
Profit Mass after Product Quantity, Gross Margin
threshold passed = sold after Total quantity (3.17)
passing the threshold of the goods sold
profitability
The strength of the operating leverage is maximum near the profitability threshold and decreases as the sales proceeds and profits grow, since the share of fixed costs in their total amount decreases until the next “jump” of fixed costs.
Margin of financial strength
Margin of financial strength- this is the difference between the achieved actual revenue from the sale of products and the profitability threshold.
Stock Revenue Threshold
financial = from - profitability (3.18)
implementation strength
For our example:
Sales proceeds - 2,000 thousand rubles.
Profitability threshold - 1,571 thousand rubles.
or 21% in relation to the volume of revenue.
Or by the second formula:
,where is the force of the operating lever.
.
(3.19)As follows from the calculations, the company is able to withstand a decrease in revenue by 21% without a threat to its financial position. If an enterprise has a high margin of financial strength (>10%), this indicates a favorable value of the impact force of the operating lever (with an optimal proportion of fixed costs) and a high level of profitability. Such an enterprise is attractive to investors, creditors, insurance companies. The greater the share of fixed costs in the cost, the more significant the relationship between sales revenue and income. For enterprises with bulky basic incomes, the high strength of operating leverage is dangerous, since in unstable economic conditions (falling effective demand, inflation), every % decrease in revenue turns into a catastrophic drop in profits. Automation leads to an increase in costs, and, consequently, to an increase in the strength of the operating leverage and entrepreneurial risk. Thus, there are both positive and negative aspects of automation. There is no single answer to the question of what is more profitable: to have high variable costs and low fixed costs, or vice versa. Each company has its own answer. It depends on financial goals, starting position and other circumstances.
3.3.5. Entrepreneurial risk. Interaction of financial and
Operating leverage
Entrepreneurial risk is associated with a loss of profit as a result of a decrease in sales or an increase in costs due to: a) volatility in demand; b) fluctuations in prices for finished products; c) an increase in the cost of purchasing raw materials and material resources.
The degree of entrepreneurial risk is determined by the strength of the operating leverage, which in turn depends on the proportion of fixed costs in the cost of production. The lower the volume of products sold, the higher the proportion of fixed costs in its cost. The level of fixed costs does not decrease during the period of falling demand for products, but vice versa, therefore, entrepreneurial risk increases.
Financial risk depends on the terms of lending (the price of borrowed funds) and capital structure and is caused by the inability to repay the loan and accrue dividends.
Economic instability leads to an increase in interest on borrowed capital and an increase in dividends on ordinary shares, as they require sufficient risk compensation in the event of liquidation of the enterprise. The degree of financial risk is determined by the level of financial leverage.
Both risks are interrelated as well as both levers.
Loss of profit as a result of entrepreneurial risk leads to the inability to pay interest on the loan and accrue dividends - financial risk increases, the effect of financial leverage decreases. The growth of interest rates associated with changes in monetary policy, the riskiness of the project, the existing capital structure, leads to a "weighting" of the fixed part of the costs and has an increased impact on the strength of the operating leverage.
The operating lever affects the amount of profit received, and the financial lever determines the share of net profit per share (dividend), as well as the level of net profit per 1 ruble of equity (return on equity).
Therefore, as the impact of operating and financial leverage increases simultaneously, small changes in revenue lead to significant changes in revenue.
This is expressed in the formula for the conjugated effect of operational and financial leverage (the strength of the impact of financial leverage is calculated on the basis of concept II).
where is the effect of conjugated levers;
Force of influence of the operating lever;
The strength of financial leverage.
This formula allows you to assess the level of the total risk associated with the enterprise, and answer the question: by what percentage will net profit change per share with a change in sales by 1 percent.
The combination of strong financial leverage with strong operating leverage can be detrimental to an enterprise, as business and financial risks multiply, exacerbating negative aspects in the enterprise's activities.
3.3.6. Dividend policy of the enterprise
Dividend policy is an integral part of the general profit management policy not only of a joint-stock company, but also of enterprises of other organizational and legal forms; only instead of the terms "dividend" will be used "share", "deposit", "profit on contribution", the same mechanism for paying income to owners is the same.
The choice of dividend policy is of the utmost importance for the enterprise, as it affects the following indicators:
As can be seen from the calculations, sales revenue increased by 9.1%, and profit by 77%.
Solving the problem of profit maximization, it is possible to increase or decrease not only variable, but also fixed costs and, depending on this, calculate by how much% the profit will increase.
Operating lever force is determined by the formula:
where is the impact force of the operating lever;
Gross margin (fixed costs + profit), in the economic literature, this indicator is called the amount of coverage.
In our example, F 0 \u003d (11 million rubles - 9.3 million rubles): 0.2 \u003d 8.5.
The number 8.5 means that with a possible increase in sales proceeds, for example, by 3%, the profit will increase by 3%8.5=25.5%.
With a decrease in sales revenue by 10%, the profit will decrease by 10%8.5=85%, and an increase in revenue by 9.1% will give an increase in profit by 9.18.5 by 77% (see above calculation).
The operating leverage formula allows you to answer the question of how sensitive the gross margin is to changes in sales volume.
The higher the fixed costs and the lower the profit, the stronger the operating leverage.
The strength of the impact of the operating lever indicates the degree of entrepreneurial risk, the greater the impact, the higher the entrepreneurial risk.
makes it possible to determine the amount of profit depending on the change in revenue.
1. Direct sales proceeds - OA.
Revenue = Selling price Sales volume = 0.5 thousand rubles. 4,000 units = 2,000 rubles.
2. Direct fixed costs (horizontal at the level of 550 thousand rubles).
3. OE - direct variable costs.
4. The direct line of total aircraft costs is parallel to the direct line of variable costs raised to a height = 550 thousand rubles. or 0.325 4,000 + 550 \u003d 1,850 rubles.
The intersection point (K) of direct revenue (OA) and total costs (BC) will be the profitability threshold, which will indicate the critical (threshold) volume of output at which income covers expenses without making a profit (break-even point).
In our example, the critical sales volume will be 3,142 units.
The threshold of profitability can also be determined by the formula:
the market value of the enterprise;
welfare of depositors;
prospects for the development of the enterprise;
prestige of the enterprise in the real estate market;
investment attractiveness.
investment opportunities of the enterprise;
the cost of raising additional capital;
the presence of a reserve of own funds formed in the previous period;
availability of loans in the market;
the level of taxation of dividends, property, profits;
the effect of financial leverage;
liquidity (lack Money makes it difficult to pay dividends; an enterprise can take a loan against the payment of dividends, but this is extremely unprofitable);
the level of dividend payments of competing firms ( low level dividends can lead to a massive "dumping" of shares; there may be a risk that the enterprise will be taken over by a competitor).
| " |
When analyzing the financial activity and economic condition of any company, one of the indicators that allows you to do this is the threshold of profitability.
The concept of the threshold of profitability
The indicator at which the proceeds received from sales with the smallest volume of sales of the enterprise covers all production costs, as well as all expenses for the sale of products, is called the profitability threshold. The profit margin will then be zero.
In other words, this variable determines how much of a product must be sold at a certain price in order to ensure profitability at which the firm will not incur losses.
Often, this indicator is also called the critical point, critical production volume or break-even point.
It should be clarified that if the revenue exceeds the profitability threshold, an increase in profits will begin.
Thus, in the case of a set price for a product, it must be sold in quantities that exceed the break-even point.
The threshold rate of return must be considered from different angles:
- Its value is intended to characterize the state of the enterprise, when it is still able to function without making a profit.
- The organization's leadership regarding this indicator will be able to plan the volume of production to increase profitability.
Influencing factors
Factors influencing the value of the threshold rate of return:
- revenue received from the sale of a unit of a good or service;
- fixed costs;
- variable costs;
If any of these indicators fluctuate, the threshold of profitability will decrease or increase.
For a more complete understanding of the significance of these factors, it is necessary to consider the concept of variable and fixed costs in more detail.
Fixed costs (conditionally fixed) are the costs of the company that do not depend on the volume of production for a specific period and remain relatively unchanged for a separate reporting period.
- rent for premises;
- deductions for depreciation;
- utilities (water supply, lighting, heating);
- funds for the issuance of wages to employees of the management apparatus of the organization;
- insurance payments;
- payment of interest on loans;
- communication costs and so on.
The peculiarity of these costs is that their organization is obliged to pay in any case, regardless of whether it is in profit or loss.
Reducing these costs is very difficult, unlike variables.
Variable costs are the costs of an enterprise that vary in direct proportion to the volume of output or services produced.
In the balance sheet of each enterprise there is such an item as "Raw materials and materials". It reflects the cost of all the funds needed by the organization for the production of products.
- Funds intended for remuneration of employees who are directly involved in the production of products.
- Fare.
- Funds for the purchase of raw materials and supplies.
- Payment for fuel and energy required for production.
- Taxes calculated from the financial result (profit tax) and others.
Formulas for calculating the threshold rate of return
The first formula: Vyrtb \u003d Zpost + Zper, where:
- Vyrtb - revenue at the break-even point;
- Zpost - fixed costs;
- Zper - variable costs;
Fixed costs are also called gross margin, which is equal to the difference between revenue and variable costs.
The threshold of profitability of each organization can be calculated in two ways:
In monetary terms: PRden \u003d Vyr * Zpost / (Vyr-Zpost), where:
- PRden - the threshold of profitability in terms of money;
- Vyr - total revenue;
- Zpost - fixed costs;
- Zper - variable costs;
In kind: PRnat=Zpost/(C-ZSper), where:
- PRnat - the threshold rate of profitability in physical terms;
- Zpost - fixed costs;
- ZSper - average variable costs (per unit of product or service);
- C - the cost of a unit of production or service;
In order to build this graph, you need to calculate the profitability threshold indicator for several production volumes and mark these points on the plane, and then draw a curve or straight line connecting them through them.
Calculation of threshold rate of return in Excel
In this program, it is incredibly convenient to carry out calculation operations.
For this you need:
- In the first column, enter data on several sales or production volumes.
- In the second column, note the fixed costs corresponding to these volumes.
- The same must be done in the third column, only for variable costs.
- In a separate cell, you must specify the cost per unit of product or service.
- In the last column, the formula for calculating the threshold of profitability is written and stretched across the entire column.
Based on this table in Excel, you can make a graph.
An example of calculating the profitability threshold
Condition: the company sells goods in the amount of 110 units at a price of 510 rubles. The amount of variable costs is 365 rubles, fixed costs per unit of production - 115 rubles. It is necessary to calculate the threshold rate of return.
Calculation in monetary terms:
- Zpost \u003d 115 * 110 \u003d 12650 rubles
- Zper=365*110=40150 rubles
- Vyr \u003d 510 * 110 \u003d 56100 rubles
- PRden \u003d (56100 * 12650) / (56100-40150) \u003d 44493.1 rubles
Thus, the organization will remain in the black if its products or services are sold for a total amount that will be higher than 44,493.1 rubles.
In other words, in the case of sales of products for a given amount, the company will be at the break-even point.
Calculation in kind:
- PRnat=12650/(510-365)=87 pieces
Consequently, the company will be able to make a profit when selling products over 87 pieces.
Enterprise profitability indicators
In order to understand how effective the activity of the enterprise is, along with the value of the threshold of profitability, it is necessary to calculate the main profitability ratios of the organization.
Profitability indicators characterize the ability of an enterprise to generate a return on invested capital.
The following variables are distinguished:
Profitability ratio of all assets. He talks about how many rubles of net profit the company extracts for the ruble of capital invested in the business. Kra \u003d PE / KAPsr, where: Kra - the desired coefficient; PE - net profit; KAPsr - the amount of assets at the end and beginning of the year, divided in half.
Return on equity ratio. It characterizes the investment attractiveness of the business and shows how many rubles per ruble of funds invested by shareholders. Krsk \u003d PE / SKsr, where: Krsk - the desired coefficient; PE - net profit; SKav - the amount of equity at the end and beginning of the year, divided in half.
Return on current assets. It indicates the efficiency of the use of current assets and operating activities. Krta \u003d PE / TAav, where: Krta - the desired coefficient; PE - net profit; TAav - the sum of current assets at the end and beginning of the year, divided in half.
Return on long-term assets. It shows how effectively non-current assets are used in general and mainly fixed assets. In addition, the indicator characterizes the investment activity of the enterprise. Krda \u003d PE / DAsr, where: Krda - the desired coefficient; PE - net profit; DAav - the amount of non-current assets at the end and beginning of the year, divided in half.
Return on sales ratio. It indicates the effectiveness of marketing activities and characterizes the demand for the company's products. Krp \u003d PE / Vyr, where:Крп - the desired coefficient; PE - net profit; Vyr - revenue.
The profitability ratio of the production cost. It shows how efficiently the company is organized and in demand, that is, how many rubles of net profit received are accounted for by one ruble of costs invested in production. Krps \u003d PE / Ss, where: Krps - the desired coefficient; PE - net profit; SS - cost.
Thus, it is necessary to conclude that it is not at all difficult to calculate the profitability threshold indicator and analyze with its help certain economic aspects of the enterprise's activities.
However, his role is extremely important. And in the case of an analysis of the economic state with the help of the main profitability ratios, it is possible to fully assess the feasibility of producing goods and services.
How to determine the threshold of profitability in 2020? For these purposes, the company uses several calculation options that allow you to get the most accurate value.
Dear readers! The article talks about typical ways to solve legal issues, but each case is individual. If you want to know how solve exactly your problem- contact a consultant:
APPLICATIONS AND CALLS ARE ACCEPTED 24/7 and 7 days a week.
It's fast and FOR FREE!
Any variety entrepreneurial activity has one main task - to maximize income. Otherwise, it doesn't make any sense.
One of the key factors that affects the receipt of income is the implementation of an effective, correct and at the same time timely financial and economic position of the company and the ability to use available resources.
The indicator of the profitability threshold is very important for the further effective business activity of any company.
The value of profitability can fully show the number of products that need to be manufactured and sold in order to pay back costs.
This rule also applies to the provision of any services. Let us consider in more detail the procedure and methods for calculating the profitability threshold.
General points
Before proceeding to consider the main issue, it is initially recommended to consider the basic theory regarding the threshold of profitability.
Additionally, it is necessary to study the legislative regulation of this issue, which, although superficial, nevertheless explains the need for calculating this indicator.
What it is
The main indicator of the effectiveness of any type of entrepreneurial activity is considered to be the income that can be predicted after determining the profitability threshold.
The threshold of profitability is such a proceeds from the sale, at which it is possible to cover all available costs without incurring losses.
In other words, financial activity is equated to zero in the process of complex application of labor, monetary and material resources.
It is often expressed using interest as well as per unit of funds that have been invested in income.
At its core, profitability is the profitability or profitability that a company can receive as a result of its entrepreneurial activities.
It can be calculated for all types of goods, which fully allows you to analyze the activities of a particular production.
Today, economics experts around the world calculate the financial position of companies using the profitability ratio, through which you can find out the likelihood of predicted investments.
Profitability of implementation - implies a value or a coefficient of the share of income in each financial unit. Moreover, it is a kind of indicator that affects the pricing policy.
The profitability of the sale is determined on the basis of the ratio of income to direct proceeds from the sale of all goods without exception.
What is the purpose of calculating
A certain threshold of profitability allows you to characterize the company's labor activity in full, rather than the income itself.
Thanks to the indicator, you can find out the general ratio of the use of resources and those that the organization currently has available.
The calculation of the indicator is used not only to analyze the activities of the organization, but also to determine the likelihood of future and pricing policies.
It is necessary to pay attention to the fact that the value of the profitability indicator of an organization, goods or sales, is determined by the ratio of the information received from net income, proceeds from the sale of goods and balance sheet.
It is necessary to pay attention to the fact that the increase in profitability (if necessary) of the company is facilitated by the direct manipulation of several important values, namely:
- accelerated growth in trade turnover;
- reducing the existing mass of costs;
- increasing the rate of return by increasing the cost.
It should be noted that in the Western market they are sure that the long-term profitability of organizations directly depends on an impressive number of factors (there are more than 30 of them) that can characterize the position of the competitive situation, as well as directly on the manufacturer's market, the current economic situation, and so on.
Based on this, it is extremely important in the process of analyzing profitability indicators not to lose sight of some other important factors, namely:
- level of capital intensity;
- existing quality of goods or provided;
- the company's current market share (domestic or international);
- labor force performance indicators.
Paying attention to such indicators can produce the most effective analysis profitability in order to improve efficiency .
Legal regulation
The legislation of the Russian Federation does not contain any specific legislative act regulating the issue of calculating and assigning a profitability threshold.
At the same time, it is necessary to pay attention to, which states:
“Financial independence or the profitability of an audited entity directly depends not only on general economic and industry factors, but also on other business conditions”
In addition, other important nuances are displayed in the specified act.
How to calculate the profitability threshold of an organization
Before proceeding with the consideration of the basic formulas for calculating profitability, it is recommended to additionally know about the graphical version.
This option is able to visually display the period and the existing circumstances in which the company's labor activity increases or, on the contrary, decreases.
The graph can be built like this:
The threshold of profitability shows the efficiency of a particular company.
What is the calculation formula
Depending on the form in which it is necessary to make profitability calculations, companies use:
Let's consider each of the formulas in more detail.
In cash
The formula for profitability in monetary terms is:
Let's consider the calculation procedure using an example. The company sells 200 units of products with a cost of 300 rubles per unit.
Variable costs for each unit are about 250 rubles. Direct costs in the cost of 1 unit - 30 rubles. Indirect direct financial costs amount to 20 rubles.
Determine the break-even point of the company. For these purposes, it is necessary to calculate the profitability threshold in value terms:
As a result of the calculations, it can be seen that the company can receive income after selling products in excess of 60 thousand rubles.
If in kind
If it is necessary to carry out calculations in kind, you need to use the formula:
In order to consider an example of calculation, the initial information from the previous version of the calculation will be taken.
Based on this, the profitability threshold will be calculated as follows:
After the obtained indicators in the calculation, we can say that the company will be able to count on a certain level of profitability after the sale of 200 units of goods.
Mathematical method of determination
The general formula for the mathematical expression of the profitability threshold is:
Calculation using such a formula does not entail difficulties. It is enough just to follow the authentically indicated information.
What factors affect the indicator
The main factors that affect the indicators of the profitability threshold are considered to be:
- the cost of selling 1 unit of goods;
- variable and fixed costs of production, sales and administration.
With the modification of these factors, the indicators of the profitability threshold may increase or decrease.
In the process of determining the profitability threshold, production costs can be divided:
- for permanent;
- and variable costs.
In the first case, we are talking about fixed or conditionally fixed costs during a specific time period.
Video: breakeven point
At the same time, it must be understood that in the process of determining for each unit of manufactured goods, the adjustment of the level of production in the organization will directly depend.
Fixed costs often include:
- financial costs for;
- depreciation charge;
- costs for;
- accrual to hired employees of the administrative apparatus;
- administrative costs and so on.
Most of the fixed costs, unlike the variable ones, are very difficult to minimize in the process of reducing production volume.
If we talk about variable generalized costs, then they directly depend on the production volume.
Variable costs that fall on each unit of manufactured goods in the future will be referred to as fixed.
Variables include:
- labor costs of hired staff;
- transport costs;
- trade and commission costs;
- the cost of purchasing the necessary material and raw materials;
- energy consumption costs and so on.
Variable costs are often those that cannot be predicted with accuracy.
Which enterprises have a higher value
It must be understood that companies begin to receive income only after, in fact, revenue begins to exceed the threshold.
In other words, the higher this indicator, the greater the margin of financial strength of the company and the size of the income itself.
Based on this, we can say that the maximum profitability indicators are available in those companies where impressive production volumes are observed with minimal costs.
How can you lower it
Gross margin increase is considered to be the only option that allows to achieve a lower profitability threshold.
In other words, marginal income, which equates to fixed costs during a critical sales period.
In such a situation, it is extremely important:
- Increase sales of goods.
- Increase the cost of goods, however, within effective demand.
- Reduce variable costs. In particular, it is necessary to reduce wages, rent, or utility bills.
- Significantly reduce fixed costs, which can increase the threshold of profitability and at the same time reflect the level of risk of doing business.
In order to ensure the efficiency of the organization and at the same time successful further development, it is extremely important to achieve a competent combination of fixed costs with a high gross margin.
Threshold of profitability - important indicator, which characterizes the financial condition of the enterprise. We calculate it in Excel, using a graphical method and using formulas.
How to understand where the border lies, beyond which the enterprise will move from a loss-making zone to a profitable one? To understand this will help the threshold of profitability. Next, you will learn what it means, how it is calculated and what is the relationship between it, as well as the margin of financial safety and operating leverage. Download the Excel model and do the calculation according to your data.
This is an indicator that gives an idea of how many products, works or services need to be produced in order to pay off the company's expenses for ordinary activities. In other words, in this case, the profit from sales is zero, as well as losses. Otherwise, it is also called the profitability of entrepreneurial activity or the break-even point.
The indicator characterizes the company from different angles. On the one hand, it reflects the state of the organization, in which the enterprise does not receive profit, but also does not have losses. This is a satisfactory financial condition. On the other hand, it allows you to determine the volume of sales or the price level at which production activities will begin to make a profit.
Profitability threshold: formula
It is calculated using one of the following formulas:
Profitability Threshold = Fixed Costs ÷ (Price - Variable Costs per Unit)
According to the above formula, the indicator is calculated in physical terms, that is, it shows how many units of products or services need to be produced in order for the enterprise to stay afloat.
Profitability Threshold = Revenue × Fixed Costs ÷ (Revenue – Total Variable Costs)
Since the calculation is based on the company's revenue received for the reporting period, as a result we will get the value of the profitability threshold in monetary terms. You can use any of these formulas, as well as the graphical method.
Get a set of profitability formulas: investments, assets, capital, sales, costs, products, core activities. Choose which indicators to consider: the effectiveness of sales, resources expended, assets or capital. Download instructions and sample reports to control the profitability of certain types of property and business processes.
Profitability threshold calculation graphically
The graphical method is the most visual method that allows you to determine and analyze the profitability threshold. To build a graph, you need to calculate revenue and variable costs for two values of sales volumes. The results obtained are plotted on a graph, where the X-axis reflects the volume of products sold, and the Y-axis shows the monetary value of revenue and costs. The chart allows you to see the position of the company, as well as to understand at what level of implementation the company begins to make a profit and when it works at a loss.
Graphically, it looks like the one shown in the diagram.
Figure 1. Threshold of profitability: graphical method
How to determine the break-even point: an example
Table 1. Initial data for the example
|
Value for Q1 2019 |
|
|
Sales volume, pcs. |
|
|
Fixed costs per unit of output |
|
|
Total Fixed Costs |
|
|
Variable unit costs |
|
|
Total variable costs |
Calculate the threshold of profitability in physical terms:
RUB 78,364 ÷ (2,999 rubles - 1,364.55 rubles) = 47.95 pcs. ≈ 48 pcs.
To reach the break-even point, the company needs to produce and sell 48 pieces of the Krokha developing music center.
Let us determine the ruble value of the same indicator. To do this, we use the second calculation formula:
(401,866 rubles × 78,364 rubles) ÷ (401,866 rubles – 182,850 rubles) = 143,787.79 rubles
It turns out that in order to reach the break-even point, the company needs to produce and sell products in the amount of 143,787.79 rubles.
If sales growth does not bring additional profit or increases it slightly, you need to find out what conditions marketing policy prevent this. To do this, it is necessary to determine the profitability of distribution channels, the rationality of the system of bonuses and discounts, and the effectiveness of commercial expenses.
Profitability threshold calculation in Excel
- determine fixed and variable costs per unit of goods, as well as sales volume;
- calculate the values of revenue, costs and profit from sales;
- find the zero value of the financial result. Revenue and natural volume of sales at this point will show the threshold of profitability.
The indicator under consideration is closely related to two more: the margin of financial strength and operating leverage. In fact, they are all united by the same analysis method that underlies - CVP (Cost-Volume-Profit). Let's take a look at how they are calculated and what they mean.
Threshold of profitability and margin of financial safety: how are they related?
The margin of financial safety is the difference between the actual or planned revenue of the enterprise and the income at the break-even point. Otherwise, it is a backlog that allows the organization to make a profit. The bigger it is, the better. For example, the break-even point for product A in your company is 1,000 units, but you sold 1,500 last month. So, the result of activity will increase by the marginal income from the sale of those 500 additional units.
________________
Note.
________________
This indicator is also called margin or margin of safety. It is calculated either in absolute terms - in rubles, or in relative terms - as a percentage. The relative value also has another name - the safety margin ratio.
Table 2. Financial safety margin: calculation formulas
Why is the revenue in the formulas given variably: both as actual and as planned? This moment depends on the period of calculation of this indicator. If you define it by the already achieved values of income for the last month, quarter or year, then take the actual value. If you are estimating future values for revenue from the newly drawn up budget of income and expenses, then use the planned value.
Let's continue with the toy manufacturer example. Let's say:
- revenue from the sale of the Krokha music center in the budget for the 1st quarter of 2020 is 497,542 rubles;
- for this, the price is planned to be raised by 5%;
- variable costs per unit will increase by 3%;
- fixed costs that fall on this product will increase by 20 thousand rubles.
Let's calculate the new value of the break-even point, and at the same time the margin of financial safety.
Table 3. Calculation of the financial safety margin
|
Indicator (in rubles, unless otherwise indicated) |
Value for Q1 2020 |
|
Initial data |
|
|
3149 ≈ 2999 × 1.05 |
|
|
Variable cost per unit |
1405.49 = 1364.55 × 1.03 |
|
Total Fixed Costs |
98 364 = 78 364 + 20 000 |
|
Estimated values |
|
|
Profitability threshold |
179 493 ≈ 98 364 ÷ (3 149 - 1 405.49) × 3 149 ≈ 57 units. × 3 149 |
|
Margin of financial strength |
318 049 = 497 542 – 179 493 |
|
Margin of financial strength, % |
63.9 = 318,049 ÷ 497,542 × 100 |
How to interpret the obtained values of the margin of safety? Here are two options:
- even if in the first quarter of 2020 sales of the Krokha music center turn out to be less than planned by 318 thousand rubles, then there will still be no loss from this product;
- the planned sales volume is almost 64% higher than the break-even one. It turns out that the organization has a significant reserve. It can be used, for example, during marketing campaign on a product in the form of a price reduction. In addition, thanks to this reserve, the company will not drive into losses an unforeseen increase in fixed or variable costs. For example, fixed costs may increase by 177 thousand rubles. (by 80%), and still the organization will remain in the profit zone. This is clearly visible on the graph.
Figure 3. Margin of financial safety on the break-even chart
Return on investment is an indicator that allows you to evaluate the effectiveness of financial investments and their payback. From English ROI (return of investment) is translated as "return on investment". This indicator should be determined both for already open projects, and for those in which the company is only planning to invest.
Download ROI Formula
Operating Lever: Formula
Operating lever in simple words is the ratio between the change in income and profit from sales. Why is it needed? For example, to quickly calculate the value of operating profit or loss when it is known by what percentage the price or sales in physical terms will increase.
For operating leverage, two formulas are derived: one for price leverage, the other for natural leverage. Both of them are based on the ratio of income to financial result. Only in the first case is taken the total income from ordinary activities (revenue), and in the second - marginal.
Table 4. Operating leverage: calculation formulas
Obviously, the value for price leverage will always be higher than for natural leverage due to the larger numerator. This has its own logic: a price increase does not entail costs, but an increase in sales leads to this. The reason is the variable component in the costs: the higher the natural volume of sales, the greater its value.
If you know what the operating leverage is, then calculating the percentage change in profit from sales will not be difficult. It is based on formulas from Table 5.
Table 5. Impact of operating leverage on profit
Of course, it is possible to calculate profit with a known changed value of price or quantity without this indicator. But the fact is that it allows you to significantly speed up the process. Here is an example.
Suppose that the management of Kolobok and Teremok decided in the second quarter of 2020 to increase the price of the Krokha music center by another 3%. Realization, according to their expectations, will decrease by 1% in the same period. How would these changes individually affect sales revenue? Let's calculate the result using the formulas from Table 5. To do this, we additionally calculate the financial result and the total marginal income.
Table 6. Calculation of operating leverage
|
Index |
Q2 2020 value |
|
Initial data (Q1 2020) |
|
|
Revenue, rub. |
|
|
Total marginal income, rub. [(Price - Variable Cost per Unit) × Quantity] |
275474.58 = (3149 – 1405.49) × 158* |
|
Profit from sales, rub. (Total contribution margin - Total fixed costs) |
177 110,58 = 275 474,58 – 98 364 |
|
Estimated values |
|
|
Price operating leverage, units |
2.81 = 497542 ÷ 177110.58 |
|
Natural operating lever, pcs. |
1.55 = 275474.58 ÷ 177110.58 |
|
Impact on sales profit through product price, % |
8.43 = 3% × 2.81 |
|
Influence on profit from sales through the price of the product, rub. |
192041 = 177110.58 × 108.43 ÷ 100 |
|
Impact on sales profit through the amount of product sold, % |
1.55 = (-1)% × 1.55 |
|
Influence on profit from sales through the amount of product sold, rub. |
174,365.37 = 177,110.58 × 98.45** ÷ 100 |
|
Note: * 158 = Revenue ÷ Unit Price = 497,542 ÷ 3,149. ** 98,45 = 100 – 1,55 |
|
We summarized all the indicators and their formulas from the article in the diagram.
Figure 4. Threshold of profitability, margin of financial safety and operating leverage: calculation formulas
The break-even point (profitability threshold) is such revenue (or the amount of production) that provides full coverage of all variable and semi-fixed costs at zero profit. Any change in revenue at this point results in a profit or loss.
To calculate the threshold of profitability, it is customary to divide the costs into two components:
· Variable costs - increase in proportion to the increase in the volume of production (sales of goods).
Fixed costs - do not depend on the number of products produced (goods sold) and on whether the volume of operations is growing or falling.
The value of the profitability threshold is of great interest to the lender, since he is interested in the question of the stability of the company and its ability to pay interest on the loan and principal. The stability of the enterprise determines the margin of financial strength - the degree of excess of sales over the threshold of profitability.
Let us introduce the notation:
The formula for calculating the profitability threshold in monetary terms:
PRd \u003d V * Zpost / (V - Zper)
The formula for calculating the profitability threshold in physical terms (in pieces of products or goods):
PRn \u003d Zpost / (C - ZSper)
The profitability threshold can be determined both graphically (see Fig. 1) and analytically.
With the graphical method, the break-even point (profitability threshold) is found as follows:
1. we find the value of fixed costs on the Y axis and draw a line of fixed costs on the graph, for which we draw a straight line parallel to the X axis;
2. select any point on the X axis, i.e. any value of sales volume, we calculate the value of total costs (fixed and variable) for this volume. We build a straight line on the graph corresponding to this value;
3. choose again any amount of sales on the x-axis and for it we find the amount of sales proceeds. We construct a straight line corresponding to this value.
The break-even point on the chart is the point of intersection of the straight lines built according to the value of total costs and gross revenue (Fig. 1). At the break-even point, the revenue received by the enterprise is equal to its total costs, while the profit is zero. The amount of profit or loss is shaded. If the company sells products less than the threshold sales volume, then it suffers losses; if more, it makes a profit.
Figure 1. Graphical definition of the break-even point (profitability threshold)
Margin Threshold = Fixed Costs / Gross Margin Ratio
You can calculate the profitability threshold of both the entire enterprise and individual types of products or services.
The company begins to make a profit when the actual revenue exceeds the threshold. The greater this excess, the greater the margin of financial strength of the enterprise and the greater the amount of profit.
How far the company is from the break-even point shows the margin of financial strength. This is the difference between the actual output and the output at the break-even point. Often calculated as a percentage of the margin of financial strength to the actual volume. This value shows by how many percent the volume of sales can decrease so that the company can avoid a loss.
Let us introduce the notation:
The formula for the margin of financial strength in monetary terms.
