Operational analysis of the organization - Finance

Operational Analysis of the Organization's Activities

Operational analysis , or CVP analysis (costs - value - profit), which tracks the dependence of financial results of an organization on the volume of production (sales), is effective method for operational and strategic planning at the organization level. The task of operational analysis is to find the most beneficial combination of variables and fixed costs, chain and volume of sales.

In the course of conducting operational analysis, the following assumptions are accepted in its standard version.

1. The classification of costs by the nature of their behavior is used when the volume of sales of finished goods (services) changes. Costs are divided into constants and variables.

2. It is assumed that all produced products (services) will be sold during the planned period of time.

3. As a criterion for analysis, profit before taxes is taken, i.e. operational, not net profit.

The object of analysis and planning is revenue and gross costs. The difference between revenue and gross costs is considered as the final result of the analysis. As part of the CVP analysis, this result is measured by operating profit - earnings before interest and taxes ( earnings before interests and taxes - EBIT ) .

The availability of operating profit in a particular period of time does not yet mean that the organization will have adequate cash flow, so its value is determined by the current assets and current debts of the organization. But if the organization for a number of periods is not able to generate operating profit, then expect a positive cash flow is not necessary. The presence of operating profit is necessary, but not sufficient condition of the organization's ability to generate money.

For the purposes of operational analysis, the so-called format of the profit statement based on margin income is used. Margin revenue ( marginal revenue - MK ) - is the proceeds from the sale of goods (services) minus variable costs. Maximizing gross margin is one of the main goals of management, since it is the source of coverage of fixed costs and the formation of profit.

In addition to marginal revenue, the key elements of operational analysis are the break-even point (profitability threshold), the financial strength of the organization, the operating leverage.

Consider these concepts in more detail.

Break-even point ( break-even point ) is defined as:

• sales volume, where revenue is equal to total costs;

• The volume of sales, where marginal revenue equals constant costs.

Once the breakeven point is reached, each additional unit of product sold (the rendered service unit) brings an additional profit equal to the invested revenue per unit of output (service).

To calculate the break-even point, simple ratios based on the revenue balance are used:

Revenue = Variable costs + Fixed costs + Profit.

A more general scheme of reasoning has the following form. Let p be the price of a service unit (output), and Q - the volume of production for a certain period of time. We will write down the basic equation of the model, symbolizing the fact that the pre-tax profit NI is determined by the total revenue minus all fixed and variable costs

ΕΒΙΤ = pQ - vQ - FC,

where v is the value of the variable costs per unit of output; FC is the total amount of fixed costs for a period of time.

The breakeven point ( BER ) by definition corresponds to the condition EBIT = 0, whence

Thus, in order to calculate the break-even point, it is necessary to divide the fixed costs by the difference between the price of the provision of services (product sales) and the value of variable costs per unit of services (products). This difference is called a single invested revenue ( unit contribution margin ).

If the task is to determine the target sales volume of Q t , ie. such value of the sales volume, which corresponds to the set operating profit EBIT t , , then we use the similar ratio:

EBIT t = pQ t - vQt - FC,


Thus, the break-even point definition allows an organization to justify prices and sales volume from the standpoint of break-even functioning, as well as determine the price and volume of sales at a level that will ensure the target profit volume.

An important characteristic of a successful organization is the safety margin (safety margin), which is defined as the difference between the planned sales proceeds and the break-even point. The higher this indicator, the safer the organization feels before the threat of negative changes (reducing revenues or increasing costs).

(operating leverage) is manifested in the fact that any change in sales proceeds always generates a stronger change in operating profit. This effect is due to the varying degree of influence of constant and variable costs on the formation of financial results of the organization's activities when the volume of production (sales) changes.

The strength of the operating leverage (level of operating leverage - DOL ) is calculated as the ratio of marginal revenue to operating profit and shows how much percent of the change in profit is given by each percent of revenue change:

The strength of the operating leverage is highest with sales close to the profitability threshold, and decreases with distance from the profitability threshold. The operating lever acts with the same force in both directions: both with increasing and decreasing sales volumes. Therefore, the greater the impact force of the operating leverage, the higher the risk associated with the organization.

Ultimately, operational analysis allows:

• to predict the cost of production and the financial result from its implementation;

• determine the critical levels of sales, variable costs per unit of output, fixed costs, prices for a given value of the relevant factors;

• establish a security zone (financial strength margin);

• evaluate the efficiency of production of certain types of goods (services)

• justify the optimal options for management decisions related to changes in production capacity, range, price policy in order to minimize costs and increase profits.

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