Profitability threshold (Рб) - cost expression Qbenzub. - how much goods must be produced to cover expenses (expenses).
Kmd - marginal income coefficient; Kmd
To calculate the profitability threshold, it is customary to divide costs into two components:
- · Variable costs - increase in proportion to the increase in production volume (sales of goods).
- · Fixed costs - do not depend on the number of products produced (goods sold) and whether the volume of operations grows or falls.
The value of the profitability threshold is of great interest to the lender, since he is interested in the question of the sustainability of the company and its ability to pay interest on the loan and the principal debt. The stability of an enterprise determines the margin of financial strength - the degree to which sales volumes exceed the profitability threshold. The profitability threshold (break-even point, critical point, critical volume of production (sales)) is the volume of company sales at which sales revenue fully covers all costs of production and sales of products. To determine this point, regardless of the methodology used, it is necessary first of all to divide the predicted costs for fixed and variable. The practical benefit of the proposed division of costs into fixed and variable (the value of mixed costs can be neglected or proportionally attributed to fixed and variable costs) is as follows:
First, it is possible to determine exactly the conditions for a firm to stop producing (if the firm does not cover average variable costs, then it must stop producing).
Secondly, it is possible to solve the problem of maximizing profit and rationalizing its dynamics for the given parameters of the company through a relative reduction in certain costs.
Thirdly, this division of costs makes it possible to determine the minimum volume of production and sales of products at which the business breaks even (the profitability threshold) and to show how much the actual production volume exceeds this indicator (the firm’s margin of financial strength).
The profitability threshold is defined as revenue from sales at which the enterprise no longer has losses, but does not receive profits, that is, financial resources from sales after reimbursement of variable costs are only sufficient to cover fixed costs and the profit is zero.
Financial strength margin
The margin of financial strength shows how much sales (production) of products can be reduced without incurring losses. The higher the margin of financial strength, the lower the risk of falling into the loss zone.
(Vf) = (Vр) - (Рb)
The margin of financial strength of an enterprise is the most important indicator of the degree of financial stability. The calculation of this indicator allows us to assess the possibility of an additional reduction in revenue from product sales within the break-even point. Both the profit and the margin of financial strength obtained with an excess of produced products are less than when sales volumes correspond to production volumes. Therefore, an enterprise interested in increasing both its financial stability and financial results should strengthen control over production volume planning. In most cases, an increase in a company's inventory indicates an excess of production. Its excess is directly evidenced by an increase in inventories in terms of finished products, and indirectly by an increase in inventories of raw materials and starting materials, since the company incurs costs for them already when purchasing them. A sharp increase in inventories may indicate an increase in production in the near future, which must also be subject to rigorous economic justification.
Thus, if an increase in an enterprise’s reserves is detected in the reporting period, one can draw a conclusion about its impact on the value of the financial result and the level of financial stability. Therefore, in order to reliably measure the amount of the financial safety margin, it is necessary to adjust the sales revenue indicator by the amount of the increase in the enterprise's inventory for the reporting period.
In the last version of the relationship - with a sales volume greater than the volume of manufactured products - the profit and margin of financial strength are greater than with the standard construction. However, the fact of selling products that have not yet been produced, that is, does not actually exist at the moment (for example, with an advance payment for a large batch of goods that cannot be produced for the current reporting period), imposes additional obligations on the enterprise that must be fulfilled in the future. There is an internal factor that reduces the actual value of the financial safety margin - hidden financial instability. A sign that an enterprise has hidden financial instability is a sharp change in the volume of inventories. So, to measure the financial strength of an enterprise, the following steps must be performed:
- · calculation of financial safety margin;
- · analysis of the impact of the difference between sales volume and production volume through correction of the financial safety margin, taking into account the increase in the company's inventory;
- · calculation of the optimal increase in sales volume and the limiter of the financial safety margin.
Operating leverage
Operating leverage (ro) is the strength of the impact of production (operating leverage) on profit - it shows the effect of economies of scale. Operating leverage shows how many times profit will change when Vр changes by 1%; this is an indicator of risk: the higher po, the higher the risk.
The amount of operating leverage may change under the influence of: price and sales volume; variable and fixed costs; combinations of any of the above factors. It should be noted that in specific situations, the manifestation of the operating leverage mechanism has a number of features that must be taken into account in the process of its use. These features are as follows:
- 1. The positive impact of production leverage begins to appear only after the enterprise has passed the break-even point of its activities, i.e. At the beginning, the company must generate a sufficient amount of marginal income to cover its fixed costs. This is due to the fact that the company is obliged to reimburse its fixed costs regardless of the specific sales volume, therefore, the higher the amount of fixed costs, the later, other things being equal, it will reach the break-even point of its activities. In this regard, until the enterprise has achieved break-even for its activities, a high level of fixed costs will be an additional negative factor on the way to achieving the break-even point.
- 2. As sales volumes continue to increase and move away from the break-even point, the effect of operating leverage begins to decline. Each subsequent percentage increase in sales volume will lead to an ever-increasing rate of increase in the amount of profit.
- 3. The mechanism of operating leverage also has the opposite direction: with any decrease in sales volume, the profit margin of the enterprise will decrease to an even greater extent.
- 4. There is an inverse relationship between operating leverage and enterprise profit. The higher the profit of the enterprise, the lower the effect of operating leverage and vice versa. This allows us to conclude that operating leverage is a tool that equalizes the ratio of the level of profitability and the level of risk in the process of carrying out production activities.
- 5. The effect of operating leverage manifests itself only in a short period. This is determined by the fact that the enterprise’s fixed costs remain unchanged only for a short period of time. As soon as another jump in the amount of fixed costs occurs in the process of increasing sales volume, the company needs to overcome the new break-even point or adapt its production activities to it. In other words, after such a leap, the effect of operating leverage manifests itself in new business conditions in a new way.
Understanding the mechanism of manifestation of operating leverage allows us to purposefully manage the ratio of fixed and variable costs in order to increase the efficiency of production and economic activities under various trends in the commodity market conditions and the stage of the enterprise’s life cycle.
The profitability threshold is characterized by the number of products sold, the revenue from which corresponds to the total costs of the enterprise. In other words, this is the sales volume at which the company does not yet make a profit, but no longer incurs losses.
Due to the proceeds received from sales, the company is able to compensate for variable costs, as well as those related to fixed ones. Even though the company will not make a profit, it will still receive marginal income, which is the difference between revenue and variable costs.
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The category of variables includes those costs that are directly related to production (the cost of raw materials, piecework wages, etc.) and are directly dependent on production activities. Fixed costs are determined by the actual need to organize production, rent premises and equipment, pay for utilities and do not depend in any way on the volume of products produced.
Highlights
What is the profitability threshold can be easily understood by imagining an enterprise just starting its activities. For some time, it will work only to recoup previously invested funds, and the moment when it succeeds, but at the same time it will have no actual profit, is precisely what is called the profitability threshold.
Determining this moment is necessary for:
- identifying conditions when a company fails to recoup average variable costs and it is advisable to terminate its activities;
- solving the problem of obtaining maximum profits and more rational distribution of resources, as well as optimizing certain costs;
- the ability to calculate the minimum volume of production and subsequent sales of goods at which the business will reach break-even level.
Important Factors
The value of profitability depends on several factors, in particular on the price at which products are sold, as well as on the level of fixed and variable costs. Changes in these factors directly affect the profitability threshold. The break-even point is calculated only after the costs have been divided into fixed and variable.
Constants do not change or change slightly over a certain period:
- salary;
- management and administrative expenses;
- utility bills.
The peculiarity of fixed costs is that they are difficult to reduce even if the volume of production itself decreases, in contrast to variables, which are directly proportional to the quantity of manufactured products.
These include:
- expenses for the purchase of raw materials and supplies;
- transportation costs;
- remuneration for workers in production professions;
- payment for consumed energy resources;
- expenses of the trading commission plan.
Classic formula
To determine the profitability threshold, physical or monetary terms can be used. In the first case, this is determined by the ratio of the sum of the enterprise's fixed costs incurred during the planning period to the difference between the cost of a unit of production and the sum of the variable costs of its production.
The calculation formula in this case is as follows: TBpcs. = Fixed costs/(Price of one unit of product - Sum of variable costs for each unit of product). The resulting value shows the minimum product that must be manufactured and sold during the planning period in order to reach the break-even level.
Due to the fact that in most cases an enterprise produces not one, but several different types of products, to determine the profitability threshold it is more advisable to use a different approach based on the total sales volume in monetary terms.
In this case, this indicator will express the ratio of the product of the amount of fixed costs incurred by the proceeds received from sales to the difference between the proceeds from sales and the cost of products that were sold.
The formula in this case is as follows:
Тbrub = Fixed costs x Sales revenue/(Sales revenue - Variable costs).
Main indicators
The most significant indicators that allow us to analyze the financial situation of the company are the following ratios:
The attractiveness of an enterprise is determined primarily by the level of its profitability, since it demonstrates the maximum interest payments that the company can afford.
Rules for calculating the profitability threshold
For each company, calculating the profitability threshold is extremely important from the point of view of obtaining more complete information about its financial condition and the ability to plan potential profits. In this case, you should be guided by certain rules.
In particular, since this metric reflects sales where the company is not yet making a profit, it is reasonable to aim for a position where revenue generated exceeds the profitability threshold.
The second rule that business management must remember is that production leverage increases in strength as the break-even point approaches. It follows from this that upon reaching a certain level exceeding the profitability threshold, an inevitable sharp increase in fixed costs occurs.
The company must certainly overcome the break-even threshold, otherwise there will be no point in its existence. At the same time, it is important to realize that at some point it will become impossible to continue production without increasing fixed costs, which, in turn, will lead to a decrease in profits in the short term.
Other nuances
Detailed instructions
The problem of finding the profitability threshold can be solved analytically or graphically. Analytical implies the calculation of this indicator using the formula: Profitability threshold - Fixed costs / gross margin ratio.
In turn, the gross margin is calculated by subtracting the amount of variable costs from the amount of revenue, and to determine its coefficient, it is necessary to divide the amount of the gross margin by the amount of revenue.
You can also use a single formula for calculating the profitability threshold as the product of fixed costs by the amount of revenue (less variable costs).
To find the break-even point using the graphical method, you must first draw the graph itself. After this, the values of fixed costs should be set on the Y axis. Drawing a line parallel to the X axis, you need to mark the constant costs on it. On the X axis itself, the sales volume point is determined, for which the sum of permanent and variable costs is calculated. A straight line is drawn using the set values.
On the X-axis, any other point in sales volumes is marked and the amount of revenue for this value is determined. Based on the obtained values, a straight line is also constructed.
The critical (or break-even point) on this chart is the point formed at the intersection of the above two straight lines. With a correctly constructed chart, you can easily compare expenses with income received from the sale of products.
The margin of financial strength is an indicator showing how much reduction in production and sales of products can be allowed without losses for the company. The concept of financial safety margin includes the entire volume of real production that occurs after the break-even point. It is calculated by subtracting the profitability threshold value from the amount of revenue.
This indicator is extremely important from the point of view of assessing how financially stable an enterprise is. Its calculation makes it possible to assess whether an additional reduction in revenue is acceptable within the break-even point.
The essence of the operating leverage effect is that with any change in the revenue received from the sale of products, profit invariably changes to an even greater extent.
Operating leverage operates due to the fact that conditionally fixed and semi-variable costs disproportionately affect the financial result in the event of a change in the volume of products produced and sold. The effect of the lever is stronger, the larger the share in the cost of production of expenses of the semi-fixed category.
The force with which operating leverage operates can be calculated by dividing the marginal profit by the profit that was received from sales. To calculate it, you need to find the difference between the revenue from the sale of goods and the amount of costs incurred for the total volume of production.
You can find out the value of profit from sales by subtracting from the amount of revenue the entire amount of funds (fixed and variable) that were spent on the entire production.
The greater the indicator of the financial strength of an enterprise, the more stable it is from a financial point of view. The goal of any company management is to increase the gap between the profitability threshold and the revenue received.
Graphically or via Excel
An example of a calculation via Excel is presented below:
- first, fixed and variable costs, as well as the cost of a unit of goods are written down in the corresponding cells;
- on the basis of them, changes in profits and costs are calculated depending on the volume of goods sold;
- permanent costs remain unchanged, regardless of the volume of output, but the sum of variables increases in proportion to production.
Another extremely popular, simple and visual way to find the break-even point is to use a chart. The profitability threshold will be located at the place where the income line intersects with the company's total cost line or where the net profit indicator is equal to zero.
How can you reduce
Among the effective methods to achieve a reduction in the level of crossing the profitability threshold, it is worth mentioning only an increase in marginal income corresponding to permanent costs at a critical sales volume.
This requires:
- increasing the volume of products sold;
- increasing the cost of a unit of goods, while ensuring compliance with the limits of effective demand;
- reduction of variable costs - salaries, rent and utility bills;
- reduction of permanent costs, which increase the value of the profitability threshold and reflect the riskiness of the enterprise’s activities.
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One of the most important stages in planning an organization’s activities is to consider options for possible changes in the market situation and the possibilities for the organization’s activities in these conditions.
One of the most accessible methods for managing business activities and financial performance is operational analysis carried out according to the scheme: costs - sales volume - profit. This method allows us to identify the dependence of the financial result on changes in costs, prices, production volume and product sales.
Using operational analysis you can:
1. assess the profitability of business activities;
2. predict the profitability of the organization;
3. assess business risk;
4. choose the optimal ways out of the crisis;
5. evaluate the profitability of investments;
6. develop the most beneficial assortment policy for the organization in the field of production and sales.
The key elements of operational analysis are the following indicators:
Critical volume of production and sales of products;
Profitability threshold;
reserve of financial strength.
Business break-even analysis is one of the main tools for solving a large class of management problems. Through such analysis, it is possible to determine the break-even point and the margin of financial strength (safety zone), plan the target production volume, set prices for products, select the most efficient production technologies, and adopt optimal production plans.
Break-even point (profitability threshold)- this is the minimum acceptable sales volume that covers all costs of manufacturing products without bringing either profit or loss.
If the company produces only one type of product, the break-even point is calculated using the formula:
TB = PZ / (C – Per.Z.ud.),
TB – break-even point, units.
FZ – fixed costs, rub.;
P – unit price, rub./unit;
Per.Z.ud. – variable costs per unit of production, rub./unit;
(C – per.Z.ud) – marginal income per unit of production, rub./unit.
In monetary terms, the profitability threshold is determined as follows:
TB = PZ / Kmd,
TB – critical revenue value, rub.
Kmd – marginal income coefficient;
Kmd = MD / N
N – sales revenue, rub.
MD = N – Per.Z.
If there is more than one type of product, the break-even point can be determined for the business as a whole or for individual types of products.
The difference between actual or planned sales revenue (Nfact, - Nplan) and the critical value of revenue (TB) characterizes financial safety margin (FS):
FFP = Nfact – TB
or FFP = Nplan - TB
An organization without the risk of losses can reduce the amount of revenue from sales by the amount of the FFP. The margin of financial strength can be determined not only in absolute terms, but also in relative terms:
KZFP = FFP / Nfact * 100%
or KZFP = ZFP / Nplan * 100%
Financial safety factor reflects the percentage of acceptable reduction in sales revenue without the risk of loss.
The safety indicator is often used to assess operational risk: the higher the indicator, the safer the situation, since the risk of lowering the equilibrium point is less.
Security questions on the topic
1. What is the role of economic analysis in planning the activities of an organization?
2. What is the purpose of budget planning in an organization?
3. What are the main methods used in developing a business plan?
4. How is the sales budget developed?
5. What does the production budget represent?
6. How is the estimate of direct material costs prepared?
7. How are estimates of labor and overhead costs prepared?
8. How is the estimated cost of production carried out?
9. What costs are considered constant and variable?
10. Using what method can total costs be divided into fixed and variable?
11. How is contribution margin calculated?
12. How is the profitability threshold calculated?
Tests
1. The total need for working capital is determined:
a) structure of equity capital
b) the profitability of production of this type of product
c) scale of production and turnover time of current assets
2. When variable costs are reduced, the organization's profitability threshold:
a) remains at the same level
b) increases
c) decreases
3. How will an increase in fixed costs affect the organization’s financial strength margin:
a) will increase
b) will decrease
c) will remain unchanged
4. How will the increase in fixed costs affect the critical sales volume?
a) the critical volume will decrease
b) the critical volume will not change
c) the critical volume will increase
5. The organization's operating budget includes:
a) budget for direct labor costs;
b) cash flow budget;
c) investment budget.
6. A forecast cash flow statement is developed based on:
A) long-term forecast of sales volume
B) budget for general business overheads
B) capital investment budget
d) forecast income statement
7. The financial indicators of the business plan must be balanced:
a) with capital intensity indicators
b) with indicators of production volume and product sales
c) with profitability indicators
8. The threshold for product profitability (the point of critical production volume) is determined by the ratio:
a) fixed costs to revenue from sales of products
b) fixed costs to variable ones
c) fixed costs to marginal income per unit of production
9. The operating budget of the enterprise includes:
a) budget for direct labor costs
b) cash flow budget
c) investment budget
10. Top-down budgeting process:
a) carried out by workers directly involved in the production process
b) requires the presence of general budget directives
c) characterized by a positive attitude of managers at lower levels of management
d) better reflects organizational goals
11. The zone of safe or sustainable operation of an organization is characterized by:
a) the difference between marginal income and fixed costs
b) the difference between marginal income and profit from product sales
c) the difference between the actual and critical volume of sales
12. Elements of costs for the production and sale of products (works, services) are:
a) raw materials, materials, fuel, energy, wages, depreciation
b) depreciation, material costs, wages, general business expenses.
13. One of the methods for drawing up a financial plan is:
a) percentage of sales method
b) method of chain substitutions
14. The organization's budget is:
a) forecast balance
b) a quantitative plan in monetary terms, showing the planned amount of income and expenses
Practical tasks
1. Determine the threshold for profitability of sales of new products (PR). The estimated price per unit of production (P) is 500 rubles. Variable costs per unit of production (PeruZ.unit) – 60%. The annual amount of fixed costs (FC) is 200 thousand rubles.
2. Determine the amount of financial safety margin, If:
sales revenue (N) is 600 tr., variable costs (Per.Z) - 300 tr., fixed costs (FZ) - 150 tr.
3. . The share of marginal income in sales revenue is 30%; sales volume at the break-even point is 600 thousand rubles. What is the amount of fixed expenses?
4. Determine the critical sales volume (TB) if:
Fixed expenses (FC) – 200t. rubles
Variable costs per unit of production (Per.Z.ed) – 800 rubles
The price of a unit of production is 1800 rubles.
5. What is the value of contribution margin, If:
Sales proceeds – 120,000 rubles.
Fixed costs – 30,000 rubles.
Variable costs - 70,000 rub.
6. Determine the point of critical sales volume (TB), If:
Sales revenue (N) – 6000t. rub.
Fixed costs (FC) – 1000 thousand rubles.
Variable costs (Per.Z) – 2000 thousand rubles.
7. Determine the amount of profit (P), If:
Marginal income (MI) – 3000t.r.
Fixed costs (FC) – 1500t.r.
Sales revenue (N) –8200t.r.
8. As of the reporting date, the organization has the following indicators:
At the beginning of the period At the end of the period
Material inventories: 2,750 3,250
Costs in work in progress 4,800 4,000
Finished products 2,500 1,250
During the reporting year the following expenses were made:
For materials – 20,000 rubles.
For labor costs – 11,000 rubles.
General production costs – 16,500 rubles.
Profitability is an indicator of effectiveness in the use of labor, economic, material and natural resources.
Profitability threshold- this is the totality of products sold, thanks to which the company covers its production costs without making a profit from sales, that is, it goes to “zero”.
If we talk about trading companies, then profitability is expressed by specific numerical characteristics, that is, by correlating profits and capital investments. A business is profitable if at the end of the year the enterprise is in the black.
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The profitability ratio is the ratio of profit to resources (material assets, flows, etc.) that form this profit.
Most often, profitability is determined as a percentage. But in some cases it can be presented in the form of profit per unit of invested assets, or in profit from each earned financial unit.
Depending on the type of business activity, profitability is classified as follows:
- Overall return on tangible assets. It is formed by the ratio of profit (before taxes) to the totality of material assets attracted to the company for a fixed period of time.
- Product profitability. It is determined as the result of dividing the profit from sales of a product by the costs of its production.
- Profitability of production. Production is considered profitable when the profit from investments exceeds the costs of producing goods. Among the methods that influence the growth of profitability are reducing the cost of manufactured products and improving quality properties.
General view of the mathematical expression of profitability:
P=P/I*100%, where:
- R– profitability;
- P– profit received during the implementation of the project;
- AND– investment in the project.
Determining the profitability threshold
It is determined by the formula:
- Profitability threshold = Fixed costs / ((Sales revenue – Variable costs) / Sales revenue).
When the profitability threshold is reached, the company has neither profit nor loss.
The break-even point is of great importance for investors, as it reflects the ability to repay the debt on the loan provided. The reliability of an enterprise is determined by the excess of the sales level over the profitability threshold.
The degree of distance between the enterprise's profitability value and the break-even point is determined by the margin of financial strength.
To obtain the value of the financial safety margin, it is necessary to find the difference between the actual number of goods produced and the number of goods produced at the break-even point.
Calculation formulas
By calculating the break-even point, we obtain the maximum amount of income from product sales. Selling goods at a reduced price makes the business unprofitable.
Thus, the company will make a profit only when the income rises above the profitability limit.
In monetary terms
Prd = VxZpost/(V – Zperem), where:
- Prd- break-even point in value terms;
- IN
- Let's lock it up- variable expenses;
- Zpost- fixed costs.
In kind
Prn = Zpost/(B - ZSperem), where
- Prn– profitability threshold, value in units of goods;
- Zpost- the value of fixed costs;
- Let's move on– average value of variable costs (per 1 product);
- IN- general level of income (revenue);
Examples
Example of calculation in monetary terms:
- The company sells 200 pcs. goods priced at 300 rubles/1 piece.
- Variable costs in the unit cost of goods are equal to 250 rubles.
- Direct costs in the cost of a unit of goods - 30 rubles.
- Indirect direct costs in the cost of a unit of goods - 20 rubles.
It is required to determine the break-even point of the enterprise.
We calculate the profitability threshold in value terms:
- Zpost= (30+20)x200 = 10,000 rub.
- Let's lock it up= 250 x 200 = 50,000 rub.
- IN= 200x300 = 60,000 rub.
- Prd= 60000x10000/(60000-50000) = 60000 rub.
The resulting break-even point reflects that the company will make a profit after selling goods worth more than 60,000 rubles.
Example of calculation in physical terms:
Prn(Profitability threshold in units of goods) = 10000/(300-250) = 200.
For an example of calculation, let's take the same input data.
Thus, the company will make a profit after selling 200 units of goods.
Key indicators
In order to analyze the financial condition of the company, the following criteria for assessing profitability are used:
- Economic profitability ratio. The return on tangible assets ratio reflects the amount of profit received from all assets that the company has. A decrease in the profitability of monetary assets is characterized by a decrease in demand for the company's products.
- Financial profitability ratio. The return on equity ratio reflects the degree of profitability of a company's capital. In this regard, this indicator is very interesting for a certain circle of people, namely, shareholders and the owner of the enterprise.
- Activity profitability ratio. This indicator is determined by the ratio of the company's net profit to net sales revenue. An increase in this indicator indicates an increase in the company’s performance, while a decrease, on the contrary, indicates its unproductive activity.
- Economic profitability- this is one of the most important criteria for the attractiveness of a company, because the level of profitability reflects the upper threshold of interest payments.
Factors affecting profitability
External
High efficiency of company management cannot reduce the level of influence of external factors on business profitability.
This type of factors includes:
- territorial location of the company (distance from sales centers, raw material deposits, etc.);
- competitiveness of the product and demand for it;
- changes in market conditions;
- the influence of the state on the economy (market regulation at the legislative level, adjustment of the refinancing rate, changes in tax laws, etc.);
Production
- means of production;
- labor resources;
The influence of these factors on the functioning of the company can be characterized from two sides:
- extensive influence (determined by changes in the numerical parameters of the production process) includes:
- changes in time and quantitative indicators of the production process;
- change in means of production (related to fixed assets: equipment, buildings, etc.) and their quantity (for example, an increase in the amount of inventories);
- change in the number of jobs, changes in work schedules, downtime;
- intensive influence is associated with increased efficiency in the use of production factors;
It includes:
- maintaining equipment in the best condition, and its timely replacement with technologically more advanced ones;
- use of modern materials, improvement of production technology;
- increasing the level of personnel qualifications, reducing the level of labor intensity of products, proper organization of the labor process.
Let's consider the enterprise profitability threshold, the calculation formula and its connection with the break-even point and the margin of financial strength.
Profitability threshold(analog.BEPbreakevenpoint, break-even point, critical point, profitability threshold)- this is the sales volume of the enterprise at which the minimum level of profit is achieved (equal to zero). In other words, the enterprise operates on self-sufficiency of its costs. The threshold for the profitability of an enterprise is sometimes called in practice.
Purpose of assessing the profitability threshold in determining the minimum acceptable level of production and sales volume, on the basis of which the margin of financial strength necessary to maintain the sustainable functioning of the enterprise is calculated. The profitability threshold is assessed both by the owners of the enterprise when planning future production and sales volumes, as well as by creditors and investors when assessing the financial condition.
When calculating the profitability threshold, two types of costs (costs) are used:
- Fixed costs (English)V.A.VariableCosts)- a type of enterprise costs, the size of which does not depend on changes in the volume of production and sales of products.
- Variable costs (English)F.C.FixedCosts)- a type of enterprise costs, the size of which directly depends on the volume of production and sales of products.
Fixed costs will include expenses for personnel wages, rental of production and other premises, deductions for the unified social tax and property tax, marketing costs, etc.
Variable costs consist of expenses for raw materials, supplies, components, fuel, electricity, bonuses for staff salaries, etc.
The sum of all fixed costs forms the total fixed and variable costs of the enterprise (TVC, TFC).
To calculate the profitability threshold of an enterprise, the following two formulas are used analytically:
BEP 1 (Breakeven point) – profitability threshold in monetary terms;
TR (Total Revenue) – revenue from product sales;
TFC (Total Fixed Costs) – total fixed costs;
TVC (Total Variable Costs) – total variable costs.
BEP 2 (Breakeven point) – profitability threshold expressed in physical equivalent (production volume);
P (Price) – unit price of goods sold;
AVC ( Average Variable Costs) – average variable costs per unit of goods.
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Calculation of the profitability threshold in Excel
To calculate the profitability threshold, it is necessary to calculate the enterprise’s fixed and variable costs and the volume of sales (sales) of goods. The figure below shows an example of the main parameters for calculating the profitability threshold.
Main parameters for assessing the profitability threshold of an enterprise
At the next stage, it is necessary to calculate how profit and costs will change based on the volume of sales of goods. Fixed costs are presented in column “B”; they will not change depending on the volume of production. Variable costs per unit will increase in proportion to production (column “C”). The formulas for calculating income and costs will be as follows:
Variable costs of the enterprise=$C$5*A10
Total enterprise costs=C9+B9
Income=A9*$C$6
Net profit=E9-C9-B9
The figure below shows this calculation. The profitability threshold in this example is achieved with a production volume of 5 units.
Estimating the profitability threshold of an enterprise in Excel
Let's assume another situation when sales volumes, variable and fixed costs are known and it is necessary to determine the profitability threshold. To do this, you can use the above analytical calculation formulas.
Profitability threshold in monetary terms=E26*B26/(E26-C26)
Profitability threshold in physical equivalent=B26/(C6-C5)
Calculation of profitability level using formulas in Excel
The result is similar to the “manual method” of determining the profitability threshold. It should be noted that in practice there are no absolutely constant or absolutely variable costs. All costs have the addition of “conditionally fixed” and “conditionally variable” costs. The fact is that with an increase in output, an “economy of scale” arises, which consists in reducing the cost (variable costs) of producing a unit of goods. Also with fixed costs, which can also change over time, for example, the rental rate for premises. As a result, when an enterprise moves from serial to mass production, an additional rate of profit and an additional margin of financial strength arise.
Determining the profitability threshold graphically
The second way to determine the profitability threshold is using a graph. To do this, we will use the data obtained above. As you can see, the profitability threshold corresponds to the point of intersection of income and total costs of the enterprise or the equality of net profit to zero. The critical level of profitability is achieved with a production volume of 5 pieces.
Graphic analysis of enterprise income and costs
Profitability threshold and margin of financial strength of the enterprise
Determining the minimum acceptable level of sales volume allows you to plan and create a margin of financial strength - this is the excess sales volume or the amount of net profit that allows the enterprise to operate and develop sustainably. For example, if the current production (sales) volume corresponds to 17 units, then the margin of financial strength will be equal to 240 rubles. The graph below shows the area of financial strength of the enterprise with a sales volume of 17 units.
Margin of financial strength of the enterprise
The margin of financial strength shows the distance of the enterprise from the break-even point; the greater the margin of safety, the more financially stable the enterprise.
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The profitability threshold allows you to assess the critical level of production of an enterprise at which its profitability is zero. This analytical assessment is important for strategic management and the development of strategies for increasing sales and planning production volumes. Currently, sales volume is influenced by many different factors: seasonality of demand, sharp changes in the cost of raw materials, fuel, energy, production technologies of competitors, etc. all this forces the company to constantly look for new opportunities for development. One of the modern promising directions for increasing production volume is the development of innovation, as this creates additional competitive advantages in the sales market.
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