The analysis of operating leverage effects based on EBIT changes

Abstract

The profit change rate is the core of performance evaluation in enterprise management, but the key point of the profit changes should be the use of operating leverage. Enterprise operators use operating leverage to increase the EBIT of their enterprise frequently, so operating leverage become the main way to influence EBIT by management methods. With factor analysis and application cases method, we will analyze impact factors of operating leverage coefficient. From the point of EBIT changes, to provide reference for increase profit by operating leverage and avoid risk for Enterprise operators. Index Terms EBIT; change; rate of change; operating leverage; effect With the background of performance evaluation which operating managers increase profit by use operating leverage effect, the effective application of operating leverage becoming the core issue of business decision. How to increase the EBIT by volume and profit leverage effect changes has become the focus of enterprise competition. Operators will always find a successful way of doing business, increase the EBIT of its enterprise by operating leverage. In practical work, the utilizing of operating leverage accompany with a certain amount of risk. It is not only has positive effect, but also has negative effect if made a mistake in judgment. Through the analysis in effect of operating leverage and its coefficient, to seek methods that increase EBIT and avoid negative effect efficiently that operating leverage might bring. 1. The Factors that Influence Operating Leverage Effect The existence of fixed costs affect the change of EBIT and sales volume, the result of the impact is that the rate of change in EBIT is greater than the rate of change in sales volume. Using operating leverage, the operator improves the enterprise's profitability and capability of risk-taking. From the perspective of management, there are three factors influencing EBIT, firstly, fixed cost, which total will not change, but fixed cost per unit will change with changes of sales volume. Secondly, variable cost, which has direct proportion with sales volume. Thirdly, the factor should be contribution margin, which reflect dependencies among unit price, unit variable costs and sales volume. These three determine the amount of EBIT, which measure operating leverage coefficient with the action of the rate of change in EBIT and sales volume, finally operating performance and risk will be present through data. A. Fixed cost Fixed cost usually means the cost that the total doesn’t change with sales volume. For example, the fixed assets depreciation is amortized through the straight-line method, the same yearly. Or the fixed Assets depreciation is accrued through accelerated depreciation methods, which doesn’t change with sales volume to influence total, and with the annual pace accelerating, the same monthly. But fixed cost will change with sales volume to influence unit fixed cost, and lead to EBIT changing. B. Variable cost Variable cost is the cost that changes with produce and sales volume in positive direction. For example, direct materials and direct labor in cost accounting, which change with produce volume, of course, they also will change with sales volume. Variable cost strongly reflects with produce and sales volume, so operators will remarkably concerned about the change of produce and sales volume. They are correlated in a positive direction. C. Contribution margin Contribution margin is an indicator which is composite relatively, or, a balance point index. It is sales revenues of product or commodity minus variable cost, equal to breakeven point. The bottom line of price strategy is contribution margin, it is a profit targets. Through equation M=p x-b x= (p-b)x=m x,We can reveals the law more clearly. M is contribution margin, p is unit product price, b is unit variable cost, x is production and consumption by product and m is unit contribution margin. Thus, we can see that when we don’t consider fixed cost, the effect of contribution margin lies on the interactions of price, variable cost, production and consumption by product. Contribution margin is proportional to unit contribution margin, production and consumption. Through the equation EBIT=p x-b x-a, we can get the conclusion that three factors influence EBIT should be fixed cost, variable cost and contribution margin. 2. Analysis in Factors that Influence Operating Leverage