There are many methods that help in making both short-term and strategic decisions on enterprise management. Perhaps one of the simplest among them is operational analysis, which is also sometimes called break-even analysis. During this process, indicators such as the amount of coverage, profitability threshold and some others are determined.
The basis of this type of analysis is the division of the enterprise’s costs of manufacturing products into variables and constants. The reason for this separation is that different costs behave differently when sales and production volumes change. So, the value of variable costs calculated per unit of output is always constant, but their total amount varies in proportion to the volume of production. But the amount of fixed costs, by contrast, is always constant, but their share in the unit cost is inversely proportional to the number of products produced.
One of the most important indicators is a critical program. It represents such a volume of production in kind that allows the company to function without loss. The profitability threshold (break-even point) is determined by multiplying the critical program by the price of the product. In other words, the profitability threshold is an indicator characterizing the level of the company's revenue at which break-even is achieved. Both of these indicators can be determined both by studying the graph, and analytically. Let us dwell in more detail on the second method.
To determine the critical program, it is required to find the amount of products that must be produced and sold to cover the entire amount of fixed costs. Thus, it is enough to divide the sum of these most fixed costs by the difference between the price and variable costs per unit. It should be noted that we proceed from the assumption that the company sells exactly the same amount of products as it produces. The threshold value of revenue, as already noted, can be found by multiplying the result in physical terms by the price.
Another indicator that requires close attention is the commercial margin. You may also come across names such as coverage amount or contribution to coverage. This indicator is determined very simply by reducing revenue by the amount of variable costs. Accordingly, the amount of coverage should cover fixed costs and generate profits. Note that commercial margin is proportional to the volume of production, but per unit its value does not change. In this regard, often determine the share of the amount of coverage in revenue. Knowing this value, we can apply another method of calculating threshold revenue — we will divide fixed costs by a fraction of the coverage amount.
To determine how far the company is from loss-making, calculate the value of the stock of financial strength. It is determined by the difference between the revenue received from the sale of products, and the threshold of profitability. This indicator can also be calculated as a share of revenue.
The last indicator that I would like to consider is operational leverage. It describes the degree of production risk, showing how many times faster changes the profit of the enterprise compared with changes in revenue. Its calculation is extremely simple and consists in the ratio of commercial margin to profit. The risk assessed by this indicator is related to the fact that a constant part is present in the cost structure. This risk is greater, the closer the company operates to the breakeven point. With an increase in revenue, the company’s activities become more secure from this point of view, since the share of fixed costs is steadily decreasing.
The calculations described above are carried out taking into account the assumption that all the dependencies are linear. Of course, real interactions are much more complicated, and, for example, the actual margin of profitability may differ from that found, but for basic analysis the methods described can be applied quite calmly.