Main purposes of calculations
The FFP is determined with the following objectives:
- If a reduction in revenue from product sales is planned, the company needs to find out to what extent sales can be reduced. The critical point is the state of the company in which it does not incur losses, but sells a minimum volume of products. That is, the organization in this case works “to zero”.
- Finding the financial stability of the company.
- Analysis of the risk of losses when reducing production.
How are “bottlenecks” (problem) points in the control system determined using the financial safety margin ?
Calculation of the ZPF provides the solution to the following tasks:
- Analysis of the financial stability indicator.
- Assessment of existing bankruptcy risks.
- Determining methods to increase financial strength.
- Establishing safe levels of sales reduction.
- Comparison of different forms of products sold.
- Ensuring a competent pricing policy.
It is recommended to determine the margin of financial strength when making serious financial decisions. The formula is relevant in various crisis situations.
Margin of financial strength, calculation example
The margin of financial strength when assessing the financial stability of a company allows one to assess the level of profitability in case of worsening market conditions.
The margin of financial safety is the difference between the actual volume of output and the volume of output at the break-even point. The higher the margin of financial strength, the greater the opportunity to maintain the designated level of profitability when sales revenue decreases.
The formula for calculating the financial safety margin is:
Zfin = Qp - Qmin
In relative terms, the formula takes the form:
Zfin = (Qp - Qmin) / Qp * 100%
where Zfin is the margin of financial strength; Qp - actual sales volume; Qmin is the sales volume at the break-even point.
Similarly, this indicator is calculated in physical terms:
Zn = (Qv - Qvmin) / Qv * 100%
where, Zn is the margin of financial strength; Qv, Qvmin - sales volume and break-even point in physical terms.
As a rule, the indicator is calculated as a percentage of the financial safety margin to the actual volume. This value shows by what percentage sales volume can be reduced in order for the company to avoid losses.
The margin of safety changes rapidly near the break-even point and more slowly as it moves away from it.
An example of calculating the financial safety margin in Excel
A good idea of the nature of this change can be obtained by plotting the dependence of the safety margin on the sales volume in physical terms.
It is possible to monitor the dynamics of the financial safety margin if the enterprise has established a management accounting system that provides for grouping the costs of production and sales of products based on their dependence on sales volume.
The growth of this indicator is facilitated by any reduction in production and sales costs, but a more significant impact is exerted by a reduction in fixed costs. In practice, three situations are possible, which will have different effects on the amount of profit and the margin of financial strength of the enterprise:
- sales volume coincides with production volume;
- sales volume is less than production volume;
- sales volume is greater than production volume.
The margin of financial strength is a more objective characteristic than the break-even point, since the profitability threshold largely depends on the volume of revenue, i.e. The break-even point of a stall and a store may differ thousands of times, but only the margin of financial strength characterizes which of the trading enterprises is in a more stable financial position.
Documents used in determining the margin of financial safety
When calculating stock, information is taken from company documents. The more accurate the initial values are, the more accurate the result will be. Let's consider the documents on the basis of which calculations are made:
- Balance sheet. It reflects retained earnings and uncovered losses. From the document you can understand the current state of the organization’s property, capital and liabilities. Based on the balance, a third-party user can analyze the company’s creditworthiness and make a decision on cooperation.
- Gains and losses report. The standard reporting period is one year. Based on the document, you can analyze the financial results of activities. The balance sheet allows you to analyze the dynamics of profit values and determine the degree of influence of third-party factors.
- Appendix to the balance sheet. Includes provisions that disclose asset and liability items.
If necessary, other documents may be used.
Formula for calculation
ZPF is determined by this formula:
Total revenue – critical revenue
The FP reserve indicator may change under the influence of the following factors:
- Production volumes and sales indicators are similar.
- Production volume values exceed sales volume values.
- Sales figures exceed production values.
If an enterprise produces too many goods, but cannot sell them, profits are low and the margin of financial strength decreases. Therefore, in order to maintain the optimal level of the indicator, you need to plan the scale of production well. Another unfavorable option is the excess of sales indicators over production indicators. In this case, the organization’s dependence on its counterparties increases.
What is the financial strength ratio?
The FP ratio is the ratio of the FP stock indicator to total revenue, expressed as a percentage. The scale of revenue reduction at which the company will begin to incur losses is determined. The ratio reflects the portion of assets that are formed from stable sources. That is, sources of financing are determined through which the company can continue its activities for a long time.
The CFP is determined by this formula:
Total revenue – critical revenue: total revenue *100
Based on the obtained indicator, one can judge the financial condition of the company.
Analysis of the obtained coefficient
A ratio of more than 10% is evidence of the company’s high financial strength, as well as increased profitability. The higher this indicator, the greater the financial strength. The closer the value is to the break-even point, the faster the FP stock changes. The inverse relationship is also true. A high value of the FP stock indicates the following processes in the company:
- Small risks of losses.
- Financial stability.
- Small revenue at which the organization does not incur losses.
Let's take a closer look at the coefficient values:
- 0.5-0.8 – relative stability of the enterprise.
- 0.2-0.5 – the company’s unstable position.
- Less than 0.2 – crisis situation, close to bankruptcy.
The FP reserve is an indicator that is constantly changing. It is recommended to regularly monitor it and analyze changes.
Calculation of financial strength indicator
Definition 2
The financial strength ratio shows how much sales can be reduced (in percentage terms) before the company begins to incur losses.
In monetary terms, this indicator is calculated as the ratio of the difference between the current volume of product sales and the sales volume at the break-even point to the current volume of product sales, expressed as a percentage.
$ZPd = ((Vr-TBd))/Vr×100%$, where:
- $ZPd$ – margin of financial strength in monetary units,
- $Вр$ – sales revenue,
- $TBd$ – sales volume at the break-even point in monetary units.
Calculation of the financial safety margin in physical terms:
$ZPn = ((Rn-TBn))/Rn ×100%$, where:
- $ZPn$ – margin of financial strength in natural units,
- $Рн$ – sales volume in natural units;,
- $TBn$ – break-even point in natural units, sales volume at the break-even point.
The financial position of an enterprise can be characterized as financially stable if the margin of financial strength (financial strength ratio) is above 10%.
The main stages of determining the margin of financial safety
To determine the FFP, this algorithm is proposed:
- Calculation of FP reserve.
- Determining the impact of the difference in the number of sales and production indicators through the correlation of the FP indicator, taking into account the growth of inventories.
- Determination of the optimal increase in the scale of implementation and the limiter of the FFP.
The obtained result is used in predicting the production rate and ensuring a stable indicator.
How to increase your financial safety margin?
To change the FP stock, the following actions are taken:
- Increase in total revenue from product sales. This is done by increasing sales volume and increasing the cost of products. It is possible to take both of these measures simultaneously.
- Increasing the indicator to the break-even point. This is done by increasing the cost of products and investing in product promotion.
- Reduced costs. This can be done by reducing variable and fixed costs.
Another method of increasing the financial reserve is to replace fixed expenses with variable ones.
Margin of financial strength as an important indicator characterizing financial stability
The indicator “Margin of Financial Strength” is one of the indicators of the stability of the financial condition of the organization.
It helps to determine to what extent, in monetary or physical terms, an enterprise can reduce production without incurring losses. Definition 1
In fact, the margin of financial strength is the difference between the actual volume of output and the volume of output at the break-even point. That is, this indicator shows how far the company is from the break-even point.
When comparing two companies, only this margin of safety will show which of the companies is in a more stable financial condition. The display of the volume of the financial safety margin on the break-even chart is shown in the figure:
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In practice, there are three options for the state of production of products, which, one way or another, affect the considered stock indicator:
- The enterprise reaches the break-even point, and the volume of products produced coincides with the volume sold. In this case, the indicator remains unchanged;
- The company produces more than it sells. Excess production leads to lost profits, and the stock indicator decreases. In this case, only rigorous planning of production volumes and careful analysis of demand will help;
- The enterprise produces less than it sells, profits grow, and the safety margin increases. At the same time, the key indicator in this case is the volume of inventories, which means there is an increase in dependence on counterparties. If there is insufficient inventory, the company will lose financial stability.
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Management Recommendations
The company's goal is to increase the stock of pharmaceutical products. To achieve this, you need to regularly analyze the PPF indicators and formulate strategies to increase the stock. To increase the stock these methods are used:
- Attracting new customers and increasing sales volume by participating in tenders.
- Changes in product costs. It must be justified in order to increase the company's income.
- Increase in production capacity.
- Reducing variable costs, which include the cost of raw materials, fuel and other resources used in production.
- Reducing fixed costs, which include salaries for low-skilled employees, automation of personnel activities.
- Introduction of innovative technologies into the company's activities to reduce costs.
Which method should you choose? It all depends on the specifics of the enterprise’s activities. For example, some companies do not want to reduce the cost of products. The price of the product can be as low as possible. It would be wiser to use funds to promote the product.
FOR YOUR INFORMATION! There are no specific ways to increase the financial stability margin. The indicator can be increased by improving the quality of the enterprise. The company's goal is to increase sales figures and make products more attractive.
