Financial and operational leverage. Dividend policy of the company

Topic 2 The concept of the effect of financial leverage in financial management

Financial leverage is an increment to the profitability of own funds obtained through the use of a loan, despite the payment of the latter.

The effect of financial leverage arises from the discrepancy between economic profitability and the average calculated interest rate (price of borrowed capital).

Financial leverage has two components:

1) differential

The differential is the difference between the economic return on assets and the average calculated interest rate on borrowed funds (ER-ATRR)

Leverage - characterizes the strength of the impact of financial leverage and is defined as the ratio borrowed money to own means ().

There is unity and contradiction between the differential and the shoulder. With an increase in borrowed funds, the financial costs associated with servicing the debt increase the average calculated interest rate, which leads to a reduction in the differential and an increase in the financial risk of the enterprise.

Effect of financial leverage = differential * leverage

EGF \u003d D * P \u003d (ER - SRSP) *

This formula is used for businesses that do not pay taxes.

Action operating lever(industrial, economic) is manifested in the fact that any change in sales proceeds always generates stronger changes in profit.

Operating lever force =

where BP is sales revenue,

PermZ - variable costs,

PostZ - fixed costs.

The strength of the operating leverage is calculated for a certain sales volume and a certain sales proceeds.

The strength of the operating leverage depends on the industry average capital intensity, i.e. the greater the value of fixed assets, the greater the fixed costs and the greater the force of operating leverage.

The operating lever characterizes the entrepreneurial risk of the enterprise (the greater the impact of the operating lever, the greater the risk).

2 . Factors affecting the strength of financial and operational leverage

The strength of the impact of operational and financial leverage together reflect the level of conjugated effect (SE f).

SE f \u003d OR * FR

The level of conjugated effect determines the level of overall risk associated with the enterprise. This indicator answers the question of how much, in percentage terms, net earnings per share change when sales volume or sales proceeds change by 1%.

The strength of the conjugate effect depends on the trace. factors:

1) demand volatility;

2) change in selling prices;

3) change in resource costs;

4) the possibility of regulating selling prices;

5) leverage - means the degree of constancy of costs. The higher the level of fixed costs of the enterprise, which do not change with a decrease (increase) in demand, the higher the risk of the enterprise.

6) use of borrowed capital. The more borrowed funds, the greater the risk, but on the other hand, the greater the profitability and less risk.

RR and FR amplify the negative impact of declining sales revenue on NREI and net income. Therefore, the enterprise is faced with the task of reducing the total risk of activity by choosing one of the options:

1) a high level of the PR effect combined with a weak effect of the OR;

2) a low level of the RF effect in combination with a strong OR;

3) moderate level of both levers.

The criterion for choosing one of the three options is the maximum market value of the share with sufficient safety for investors.

Determining the associated effect allows you to determine the dividend policy of the enterprise, because. allows you to determine what will be the net income per share at a certain percentage change in sales revenue.

Net earnings per share in the future period =

(net earnings per share in the current period)* (1 + SE f * % VR)

where % VR is the percentage change in sales revenue.

3. The threshold of profitability and the margin of financial strength of the enterprise

The threshold of profitability is such revenue from sales at which the company no longer has losses, but still does not have profit. At the same time, the gross margin is only enough to cover fixed costs.

Threshold of profitability =

kVM - gross margin ratio - share of gross margin in sales proceeds.

The margin of financial strength of an enterprise is the difference between the sales proceeds and the threshold of profitability. It shows how far the sales revenue goes from the profitability threshold. The higher the threshold of profitability of the enterprise, the more difficult it is to create a margin of financial strength for the enterprise.

Threshold quantity of goods = - this formula is used for an enterprise that does not have a nomenclature (that is, it produces one product).

If the company produces several types of products, then it is necessary to take into account the share of each product in the total sales proceeds.

If the profitability threshold has already been passed, then the enterprise has an additional amount of gross margin for each unit of goods, i.e. the amount of profit increases. The mass of profit (P) after passing the threshold of profitability is determined by:

Advanced operational analysis

An in-depth operational analysis is based on the division of fixed costs into direct fixed and indirect fixed costs.

Direct fixed costs are related to a specific product (for example, renting a workshop).

Indirect fixed costs are not directly related to the production of goods ( wage directors, depreciation of the administrative building, etc.). Indirect costs can be distributed among the goods in proportion to the share of each product in the proceeds from the sale of the enterprise.

The main principle of in-depth operational analysis is the combination of straight lines variable costs for this product with direct fixed costs and the transfer of an intermediate margin.

Intermediate margin is the result of sales after direct variable and direct fixed costs have been allocated. With the help of an intermediate margin, it is determined which goods it is profitable for the enterprise to produce and which prices to set. The intermediate margin is intermediate between profit and gross margin. When calculating the intermediate margin, it should be determined whether it covers at least part of the fixed costs of the enterprise. If at least part of the costs is covered, then this product can remain in the assortment structure of the enterprise. Preference should be given to products that incur the maximum fixed costs of the enterprise.

An in-depth operational analysis requires the calculation of the break-even threshold, which is the amount of sales revenue that covers variable costs and direct fixed costs. In this case, the intermediate margin d.b. equals 0. If the intermediate margin does not correspond to zero, then this product must be removed from production, or this product should not be planned for production.

Breakeven threshold =

Breakeven threshold =

Intermediate margin ratio is the share of intermediate margin in sales proceeds.

In addition to the assortment structure, in-depth operational analysis allows you to track life cycle goods.

t.A - implementation - only variable costs are covered;

t.B - growth - the breakeven threshold is reached;

t.S - maturity - the threshold of profitability is reached;

etc. - the threshold of profitability is reached;

i.e. - the breakeven threshold is reached.

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 may 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 produce 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.

The ability to account for changes in costs and revenues by applying sensitivity analysis is more general view explore the possibilities 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 the total number of customers for the year was 400. One of the opportunities to improve things is more effective use one of the rooms of the premises, which is now reserved for the 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 hiring qualified personnel at an annual cost of UAH 9,000 and an investment of 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 by a different ratio of 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.

1. Operating lever
2. 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:

1. Normative.

Budgeting

Budgeting tasks:

1. Sales budget.
2. production budget.
3. Business expenses budget.
4. Forecast profit report.

The financial budget includes:

1. Investment budget.
2. Budget Money.
3. Forecast balance.

Financial risk management

Essence and classification of financial risks

Ways to assess the degree of risk

Long term and short term financial policy enterprises

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 to analyze and evaluate 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 in 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

1. Operating lever
2. 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);

The high proportion of fixed costs limits the ability to manage current 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, conditionally variable costs - 250 million rubles, conditionally fixed costs - 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 - the average annual amount of equity capital.

Funding rules:

1. If attracting additional borrowed funds gives a positive EGF, then such borrowing is profitable.
2. 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

1. Financial planning in the system financial management
2. Enterprise Budget and Budget Development Process
3. Determining the need for additional funding

Financial planning - management of the process of creation, distribution and use financial resources in an enterprise that is implemented in detailed financial plans.

The main stages of the planning process:

1. Analysis of investment and financing opportunities available to the company.
2. Predicting the consequences of current decisions, that is, determining the relationship between current and future decisions.
3. Justification of the developed option from several possible solutions.
4. 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:

1. The compliance principle is that the acquisition of current assets is planned mainly from short-term sources.
2. The principle of constant need for own working capital.
3. The principle of excess cash, that is, the company must have a certain reserve to cover current needs.
4. When developing financial plans several planning methods are used.

Planning methods:

1. Balance - determining the correspondence between income and expenses.
2. Normative.
3. 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 as part of operational planning, that is, based on strategic goals.

Budgeting tasks:

1. Ensuring current planning.
2. Ensuring coordination, cooperation and interrelationships in the division of the enterprise.
3. Justification of the costs of the enterprise.
4. 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:

1. Sales budget.
2. production budget.
3. Budget production stocks.
4. Budget for direct material costs.
5. Production overhead budget.
6. Budget for direct labor costs.
7. Business expenses budget.
8. Budget management expenses.
9. Forecast profit report.

The financial budget includes:

1. Investment budget.
2. Cash budget.
3. Forecast balance.

The unit of reference is the month.

Determining the need for additional financing is the main task of financial planning. When solving the problem, the following sequence of actions is possible:

1. Formation of a forecast report on profit for the planned year.
2. Preparation of the company's balance sheet for the planned year.
3. Deciding on sources of additional funding.
4. 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. Ceteris paribus, 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.

In general, 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 coefficient operating profitability (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

In the reporting period, the companies demonstrated 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 contribution margin 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 higher operating income growth potential.

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.

Operating leverage indicates the level of entrepreneurial risk this enterprise: the greater the silt of 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 size of the ratio of borrowed capital 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 profit on equity, which allows you to increase the coefficient of its profitability. 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 the average value of 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.

1. 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.
2. 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.