By Adjunct Professor C Foo James Leong, FCA and Author of “Financial Storytelling: Once Upon a Balance Sheet”
Introduction
To achieve remarkable profit growth, it is crucial to comprehend the potential of operating leverage and effectively communicate financial insights. Singapore Airlines (SIA) serves as a prime example of how operating leverage can drive transformative financial results. Despite facing an operating loss of SGD0.6 billion in 2022, SIA achieved a remarkable financial turnaround this year, generating its highest profit in 76 years with revenue of SGD17.8 billion and an impressive operating profit of SGD2.7 billion. In this blog post, we will explore the concept of operating leverage, its impact on profitability, and strategies to leverage it for unlocking outstanding financial success. By empowering your team with financial fluency, you can unleash the true potential of operating leverage.
Understanding Operating Leverage
Operating leverage is a fundamental concept that examines the influence of fixed costs on a company's profitability. Fixed costs, such as depreciation and staff salaries, remain constant regardless of sales volume. The true power of operating leverage lies in the fact that as revenue increases, fixed costs do not rise proportionally. Instead, a larger portion of the revenue directly contributes to the bottom line, resulting in higher profits. It results in a multiplier effect that amplifies your success.
Example:
Let's consider an example to illustrate the impact of operating leverage. Initially, with sales of $100, cost of goods sold at $30, and operating expenses at $50, the operating profit stands at $20. Now, if sales increase by 10%, resulting in $110 in sales, and assuming the cost of goods sold increases proportionally to $33, the operating profit rises to $27. This demonstrates the power of operating leverage as the operating profit increases by 35%, surpassing the 10% increase in sales. The existence of fixed costs in the business cost structure magnifies profitability as revenue grows.
Scaling Revenue Strategically: Expanding Horizons for Profit Growth
Operating leverage presents a unique opportunity to scale revenue without a proportional increase in fixed costs, unlocking significant growth potential. By developing financial fluency and understanding the financial implications of business decisions, entrepreneurs and leaders can identify strategic opportunities for revenue scaling. Diversifying product offerings, exploring new markets, and adapting business models become tangible pathways to unlock growth potential. Effective financial communication and collaboration enable non-finance team members, regardless of their roles in operations, to align their actions with financial objectives and maximise profit growth.
Optimising Fixed Costs: Enhancing Efficiency for Greater Profits
To further unlock the power of operating leverage, businesses must optimise their fixed costs without compromising quality. This necessitates empowering individuals across the organisation to identify opportunities for cost reduction while maintaining operational excellence. Every expense presents an opportunity to tell a compelling financial story, highlighting the potential for cost optimisation and improved profitability.
Let's delve into the example once again and explore the effects of a 10% sales increase combined with a 5% reduction in operating expenses. As a result of these adjustments, the sales figure climbs to $110, accompanied by a cost of goods sold of $33 and operating expenses totalling $47.50. The impact on operating profit is significant, as it reaches $29.50.
This represents an impressive 47.5% increase in operating profit, surpassing the initially projected 35% increase. It's worth noting that such a substantial improvement can be achieved with just a modest adjustment in operating expenses. This highlights the potential for businesses to enhance their profitability by strategically managing both sales growth and expense reduction.
Embracing Technology and Innovation: Harnessing Modern Tools for Financial Success
In today's fast-paced business landscape, staying ahead requires embracing technological advancements as catalysts for operating leverage and profit growth. Leveraging innovative solutions such as artificial intelligence and process automation allow businesses to optimise operations, improve efficiency, and further reduce costs.
Conclusion
Operating leverage holds the key to unlocking remarkable profit growth for businesses. By empowering your team with financial acumen and understanding the impact of fixed costs and revenue growth, entrepreneurs and leaders can transform their business prospects. Through strategically scaling revenue, optimising fixed costs, and embracing technology and innovation, businesses can unleash their full potential.
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About the Author
C Foo James, an adjunct professor at National University of Singapore, is the visionary author behind the ground-breaking book, 'Financial Storytelling: Once Upon a Balance Sheet.' With an unwavering commitment to demystify finance, James seamlessly blends his extensive financial expertise with captivating storytelling skills as a Distinguished Toastmaster. Through his innovative approach, he has successfully revolutionised financial education, injecting it with a delightful dose of enjoyment. Join the ever-growing community of leaders, executives, and entrepreneurs who have discovered endless inspiration and invaluable guidance on the transformative journey to financial mastery through James's unparalleled expertise and visionary reimagination of financial education.