The reason for having a high fixed cost ratio relative to the cost structure may be due to increased capital expenditure and investments in increasing production capacity and improving labor productivity. Based on this, this state of affairs is not always something negative for creditors and investors.
If the organization's managers analyze the dynamics and effect of operating leverage, they can more quickly conduct pricing operations, reduce fixed costs, and determine the minimum acceptable value of profitability when creating production and investment programs.
Production and financial leverage
To understand the total level usages of car owner database of business and financial risks, you can use the formula for the combined effect of operational and financial leverage. This allows you to determine the so-called total leverage. Using this indicator, you can find out by how many percent the profit before taxes will change after interest is paid if revenue increases or decreases by 1%.
Production and financial leverage
The conjugate effect of leverage is usually denoted as DTL (from English Degree of Total Leverage) . The formula looks like this:
DTL = DFL * DOL
Where:
DTL – the level of the combined effect of operational (DOL) and financial (DFL) leverage.
Based on this, on the basis of operational and financial leverage, it is possible to regulate and predict the return on invested capital, as well as the overall level of risk.
For example, you can increase operating leverage by increasing borrowed capital. However, a situation in which an organization has increased operating leverage and at the same time high financial leverage is quite risky. This situation can lead to an increase in the negative impact of declining sales revenue on the net profit value.
For this reason, leverage is used in the process of finding the most suitable capital structure, which is a kind of compromise between risk and profitability.
Case: VT-metall
Find out how we reduced the cost of attracting an application by 13 times for a metalworking company in Moscow