CHAPTER 6 DYNAMICS AND GROWTH OF THE BUSINESS SYSTEM In Chapter 2 we characterized the business system as a dynamic growth model and described in broad terms the interrelationship of decisions, financial yard- sticks, and management policies used in the pursuit of shareholder value creation. In the previous three chapters, we dealt with several specific aspects of financial management: the movement of cash through the system, the evaluation of the fi- nancial results of the system, and the projection of future financial requirements. We ended Chapter 5 with a broad description of financial modeling as a valuable assist in developing financial projections, after demonstrating basic pro forma and cash budgeting processes as common tools for financial planning. Now we need to return to our systems concept and become more specific about how some of the system’s internal characteristics and dimensions affect changes in the cash flow patterns that lead to shareholder value creation. There are two important subjects that so far we’ve touched on only briefly, but that are an integral part of understanding and modeling the business system, namely leverage and the potential for growth. The reader will recall that financial leverage and the funding potential with which to support growth were represented in the financing sector of the business system diagram. We also recognized the in- terplay of fixed and variable costs in the operational sector. At the time we briefly indicated the trade-offs and choices that could be made by management in dealing with these areas. Now it’s time to integrate these concepts into a more thorough financial planning discussion that deals with the operational and policy drivers underlying the pro forma statements and cash budgets covered in the previous chapter. We’ll focus first on the concept of leverage—the impact of fixed elements on overall results—in two critical areas: • Operating leverage. • Financial leverage. 191 hel78340_ch06.qxd 9/27/01 11:13 AM Page 191 Copyright 2001 The McGraw-Hill Companies, Inc. Click Here for Terms of Use. 192 Financial Analysis: Tools and Techniques Here we’ll explore in detail the impact of volume changes on profitability under a variety of assumptions about the nature and level of fixed elements in the company’s cost pattern, and deal with their implications for structuring and man- aging the operational part of the system. Then we’ll illustrate the impact of finan- cial leverage on a company’s profitability, and how the introduction of fixed interest charges into the financial system can both benefit a company’s return and magnify the variability of these returns, based on a trade-off of risk versus return. Last, we’ll turn to an integrated modeling approach that’ll demonstrate the drivers of growth in the system and their financial implications. Our focus will be on testing the financial impact of top-level policy changes in investment, opera- tions, and financing. The vehicle for this process will be a basic financial growth plan format, which in a highly summarized way allows us to visualize the inter- relationship of the key financial dimensions and drivers affecting the performance and growth of the total business system. We’ll cover the following concepts in detail: • The basic financial growth model. • Determining sustainable and affordable growth. • The integrated financial plan. The reader is encouraged to revisit the first section of Chapter 2, which de- scribes the business system and its key linkages, many of which we’ll test in this discussion. The broader concept of shareholder value creation will be dealt with extensively in Chapter 12. Leverage Leverage, as previously mentioned, refers to the often favorable, but at times problematic, condition of having within the overall cost pattern of the business system a stable element which supports a wide range of activity. Operating lever- age simply means that part of the ongoing costs of a business are fixed over a broad range of operating volume. As a result, profits are boosted or depressed more than proportionally for given changes in sales volume. The phenomenon is positive as long as volume is increasing; when volume turns down due to un- favorable market conditions, there can be a large negative impact on operating profit. Similarly, financial leverage occurs when a company’s capital structure contains obligations with fixed interest rates. Earnings after interest and return on equity are boosted or depressed more than proportionally as volume and profit- ability fluctuate. However, there are differences in the specific elements involved and in the methods of calculation of each type of leverage. Both operating and fi- nancial leverage can be present in any business, depending on the choices made by management in structuring operations and the financing requirements, and the respective impact on net profit will tend to be mutually reinforcing. We need to understand the specific impact of leverage whenever it’s encountered in a busi- ness, as it is an important element in the financial planning process. hel78340_ch06.qxd 9/27/01 11:13 AM Page 192 CHAPTER 6 Dynamics and Growth of the Business System 193 Operating Leverage Distinguishing between fixed and variable costs (those costs that vary with time and those that vary with the level of activity) is an old idea. This separation of costs by behavior is the basis for break-even analysis. The idea of “breaking even” is based on the simple question of how many units of product or service a business must sell in order to cover its fixed costs before beginning to make a profit. Pre- sumably, unit prices are set at a level high enough to recoup all direct (that is, vari- able) unit costs and leave a margin of contribution toward fixed (period) costs and profit. Once sufficient units have been sold to accumulate the total contribution needed to offset all fixed costs, the margin from any additional units sold will be- come profit—unless a new layer of fixed costs has to be added at some future point to support the higher volume. Understanding this principle will improve our insight into how the opera- tional aspects of a business relate to financial planning and projections. This knowledge is also helpful in setting operational policies, which, especially in a volatile business setting might, for example, focus on minimizing fixed costs through outsourcing certain activities. But in a broader sense, it’ll allow us to ap- preciate the distorting effect which significant operating leverage might exert on the measures and comparisons used in financial analysis. A word of caution must be added here. There’s nothing absolute about the concept of fixed costs, because in the long run, every cost element becomes vari- able. All costs rise or fall as a consequence of management policies and decisions, and can therefore be altered. As a result, the break-even concept must be handled with flexibility and judgment. As we mentioned, introducing fixed costs to the operations of a business tends to magnify profits at higher levels of operation up to the point when another layer of fixed costs might be needed to support greater volume. This is due to the buildup of incremental contribution which each additional unit provides over and above the strictly variable costs incurred in producing it. Depending on the pro- portion of fixed versus variable costs in the company’s cost structure, the total in- cremental contribution from additional units can result in a sizable overall jump in profit. Analyzing a leveraged operating situation is quite straightforward. Once all fixed costs have been recovered through the cumulative individual contributions from a sufficient number of units, profits begin to appear as additional units are sold. Profits will grow proportionally faster than the growth in unit volume. Un- fortunately, the same effect holds for declining volumes of operations, which re- sult in a profit decline and accelerating losses that are disproportional to the rate of volume reduction. Operating leverage is definitely a double-edged sword! We can establish the basic definitions as follows: Profit ϭ Total Revenue Ϫ Total Cost Total Revenue ϭ Volume (Quantity) ϫ Price Total Cost ϭ Fixed Cost ϩ Variable Cost hel78340_ch06.qxd 9/27/01 11:13 AM Page 193 194 Financial Analysis: Tools and Techniques The formal way of describing leverage conditions is quite simple. We’re in- terested in the effect on profit (I) of changes in volume (V). The elements that bear on this are the unit price (P), unit variable costs (C), and fixed costs (F). The rela- tionship is: I ϭ VP Ϫ (VC ϩ F) This formula can be rewritten as: I ϭ V(P Ϫ C) Ϫ F which illustrates that profit depends on the number of goods or services sold times the difference between unit price and unit variable cost—which is the contribution to the constant element, namely fixed costs. As unit volume changes, the unit contribution (P Ϫ C) multiplied by the change in volume will equal the total change in profit. Under normal conditions, the constant, fixed costs (F) will remain just that. The relative changes in profit for a given change in volume will be magnified because of this fixed element. Another way of stating the leverage relationships is to use profit as a percent of sales (s), one of the ratios developed in Chapter 4. Using the previous notation, s ϭ and defining I in terms of the components, the formula becomes: s ϭ and slightly rewritten: s ϭ The relationship indicates that the profit/sales ratio depends on the contri- bution per unit of sales, less fixed costs as a percent of sales revenue. We observe that, to the extent fixed costs are present, they cause a reduction in the profit ratio. The larger F is, the larger the reduction. Any change in volume, price, or unit cost, however, will tend to have a disproportional impact on s because F is constant. Now let’s examine how the process works, using some concrete examples. We’ll use the cost/profit conditions of a simple business with relatively high fixed costs of $200,000 in relation to its volume of output and variable costs per unit. The fixed costs are largely overhead and costs related to owning and operating the production facilities, including the depreciation effect. Our company has a maxi- mum level of production of 1,000 units, and for simplicity, we assume there’s no lag between production and sales. Units sell for $750 each, and variable costs of materials, labor, and supplies amount to $250 per unit. Every unit therefore pro- vides a contribution of $500 toward fixed costs and profit. ΄ 1 Ϫ C P ΅ Ϫ F VP V(P Ϫ C) Ϫ F VP I VP hel78340_ch06.qxd 9/27/01 11:13 AM Page 194 CHAPTER 6 Dynamics and Growth of the Business System 195 Figure 6–1’s break-even chart is a simple representation of the conditions just outlined. At zero volume, fixed costs amount to $200,000, and they remain level as volume is increased until full capacity has been reached. Variable costs, on the other hand, accumulate by $250 per unit as volume is increased until a level of $250,000 has been reached at capacity, for a total cost of $450,000. Revenue rises from zero, in increments of $750, until total revenue has reached $750,000 at capacity. Where the revenue and variable cost lines cross (at 400 units of output), a break-even condition—no profit and no loss—has been reached. This means that FIGURE 6–1 ABC CORPORATION Simple Operating Break-Even Chart* Total revenue – Price of $750/unit Variable costs of $250/unit $800 700 600 500 400 300 200 100 0 Thousands of dollars Contribution per unit Revenue Variable costs Contribution Break-even volume 400 units Profits Break-even point Fixed costs of $200,000 Losses 100 200 300 400 500 600 700 800 900 1,000 $750 250 $500 Profits and Losses as a Function of Volume Changes of 25 Percent Volume Increase Profits Increase 400 . . . . . . . . . . — -0- — 500 . . . . . . . . . . 25% $ 50,000 Infinite** 625 . . . . . . . . . . 25 112,500 125% 781 . . . . . . . . . . 25 190,500 69 976 . . . . . . . . . . 25 288,000 51 Volume Decrease Losses Increase 400 . . . . . . . . . . — -0- — 300 . . . . . . . . . . 25% $ 50,000 Infinite** 225 . . . . . . . . . . 25 87,500 75% 169 . . . . . . . . . . 25 115,500 32 127 . . . . . . . . . . 25 136,000 18 *This diagram is available in an interactive format (TFA Template)—see “Analytical Support” on page 222. **Infinite because the base is zero. hel78340_ch06.qxd 9/27/01 11:13 AM Page 195 196 Financial Analysis: Tools and Techniques the total cumulative revenue of $300,000 at that point is just sufficient to offset the fixed costs of $200,000, plus the total variable costs of $100,000 (400 units at $250 each). If operations increase beyond this point, profits are generated; at vol- umes of less than 400 units, losses are incurred. The break-even point can be found numerically, of course, by simply dividing the total fixed costs of $200,000 by the unit contribution of $500, which results in 400 units, as we expected: Break-even point (I ϭ zero): ϭ V Zero profit ϭ ϭ 400 units The most interesting aspect of the break-even chart, however, is the clear demonstration that increases and decreases in profit are not proportional. A series of 25 percent increases in volume above the break-even point will result in much larger percentage jumps in profit growth. The relevant change data are displayed in the table under the chart. They show a gradual decline in the growth rate of profit from infinite to 51 percent. Similarly, as volume decreases below the break-even point in 25 percent decre- ments, the growth rate of losses goes from infinite to a modest 18 percent, as volume approaches zero. Thus, changes in operations close to the break-even point, whether up or down, are likely to produce sizable swings in earnings. Changes in operations well above or below the break-even point will cause lesser fluctuations. We must be careful in interpreting these changes, however. As in any per- centage analysis, the specific results depend on the starting point and on the rela- tive proportions of the components. In fact, managers will generally be much more concerned about the total dollar amount of change in profit than about per- centage fluctuations. Moreover, it’s easy to exaggerate the meaning of profit fluc- tuations unless they are viewed carefully in the context of a company’s total cost structure and its normal level of operations. Nevertheless, the concept should be clear: The closer to its break-even point a firm operates, the more dramatic will be the profit impact of volume changes. The analyst assessing a company’s performance or making financial projections must attempt to understand where the level of its current operations is relative to normal volume and the break-even point, and then interpret the analytical results accordingly. Clearly, the greater the relative level of fixed costs, the more powerful the effect of operating leverage becomes. Therefore, we need to understand this as- pect of the company’s cost structure. In capital-intensive industries, such as steel, mining, forest products, and heavy manufacturing, most of the costs of production are indeed fixed for a wide range of volumes. This tends to accentuate profit swings as companies move away from break-even operations. Another example is the airline industry, which from time to time substan- tially increases the capacity of its flight equipment. The fixed costs associated $200,000 $500 F P Ϫ C hel78340_ch06.qxd 9/27/01 11:13 AM Page 196 TEAMFLY Team-Fly ® CHAPTER 6 Dynamics and Growth of the Business System 197 with leasing and operating these expensive aircraft initially cause sharp drops in profit for many airlines. As business and private travel rise to approach the new levels of capacity, well-managed airlines experience dramatic improvements in profits, while marginal performers continue to suffer losses. In contrast, service industries, such as consulting firms, can directly influence their major cost— salaries and wages—by adjusting the number of employees as demand changes. Thus, they’re much less subject to the effects of the operating leverage phenome- non. In many businesses, the use of temporary or contract employees has risen dramatically in recent years, reflecting the desire to reduce in part the more long- term obligations associated with regular employees. As we mentioned before, in most situations management should assess whether there would be value in reducing the level of fixed costs through creative solutions such as outsourcing, partnering, and contract work arrangements that move the responsibility for fixed expense obligations elsewhere. Such assess- ments became a growing phenomenon in the 90s during the widespread efforts at corporate restructuring and reengineering. Naturally, there are trade-offs involved in such choices, such as giving up control over what might be important elements of value-creating activities. There are three main elements management can influence in the operating leverage relationship: • Fixed costs. • Variable costs. • Price. All three are in one way or another related to volume. We’ll demonstrate the effect of changes in all three by varying the basic conditions in our example. Effect of Lower Fixed Costs If management can lower fixed costs through energetic reductions in overhead by using facilities more intensively, by contracting out part of its production, or through other restructuring of the company’s activities, the break-even point might be lowered significantly. As a consequence, the boosting effect on profits will start at a lower level of operations. Figure 6–2 shows this change. Note that reducing fixed costs by one-eighth has led to a corresponding reduction in break-even volume. It will now take one-eighth fewer units contrib- uting $500 each to recover the lower fixed costs. From the table we can observe that successive 25 percent volume changes from the reduced break-even point lead to increases or decreases in profit that are quite similar to our first example in Figure 6–1. Reducing fixed costs, therefore, is a very direct and effective way of lowering the break-even point to improve the firm’s profit performance. Effect of Lower Variable Costs If management is able to reduce the variable costs of production (direct costs), thereby increasing the contribution per unit, the action can similarly affect profits hel78340_ch06.qxd 9/27/01 11:13 AM Page 197 198 Financial Analysis: Tools and Techniques at current levels and influence the movement of the break-even point itself. In Fig- ure 6–3, we’ve shown the resulting change in the slope of the variable cost line, which in effect widens the area of profits. At the same time, loss conditions are reduced. However, the change in break-even volume resulting from a 10 percent change in variable costs is not as dramatic as the change experienced when fixed costs were lowered by one-eighth. The reason is that the reduction applies only to a small portion of the total production cost, as variable costs are relatively low in this example. (This illustrates the point we made earlier about having to consider the relative cost proportions in this type of analysis.) FIGURE 6–2 ABC CORPORATION Simple Operating Break-Even Chart: Effect of Reducing Fixed Costs (reduction of $25,000) $800 700 600 500 400 300 200 100 0 Thousands of dollars Contribution per unit Revenue Variable costs Contribution $750 250 $500 Break-even volume 350 units Profits Break-even point Fixed costs of $175,000 Losses 100 200 300 400 500 600 700 800 900 1,000 Original condition Profits and Losses as a Function of Volume Changes of 25 Percent Volume Increase Profits Increase 350 . . . . . . . . . . — -0- — 438 . . . . . . . . . . 25% $ 44,000 Infinite* 547 . . . . . . . . . . 25 98,500 125% 684 . . . . . . . . . . 25 167,500 69 855 . . . . . . . . . . 25 252,000 51 Volume Decrease Losses Increase 350 . . . . . . . . . . — -0- — 262 . . . . . . . . . . 25% $ 44,000 Infinite* 196 . . . . . . . . . . 25 77,000 75% 147 . . . . . . . . . . 25 101,500 32 110 . . . . . . . . . . 25 120,000 18 *Infinite because the base is zero. hel78340_ch06.qxd 9/27/01 11:13 AM Page 198 CHAPTER 6 Dynamics and Growth of the Business System 199 Only at the full capacity (1,000 units) does the profit impact of $25,000 cor- respond to the effect of the reduction of $25,000 in fixed costs in the earlier ex- ample. At lower levels of operations, lower unit volumes and the lesser impact of variable costs combine to minimize the effect. Nevertheless, the result is a clear improvement in the break-even condition, and a profit boost is achieved earlier on the volume scale. Again, 25 percent incremental changes are tabulated to show the specific results. FIGURE 6–3 ABC CORPORATION Simple Operating Break-Even Chart: Effect of Reducing Variable Costs (reduction of $25 per unit) Profits Losses Variable costs of $225/unit $800 700 600 500 400 300 200 100 0 Thousands of dollars Contribution per unit Revenue Variable costs Contribution Fixed costs of $200,000 $750 225 $525 Break-even volume 381 units Break-even point 100 200 300 400 500 600 700 800 900 1,000 Original condition Profits and Losses as a Function of Volume Changes of 25 Percent Volume Increase Profits Increase 381 . . . . . . . . . . — -0- — 476 . . . . . . . . . . 25% $ 49,900* Infinite† 595 . . . . . . . . . . 25 98,500 125% 744 . . . . . . . . . . 25 167,500 69 930 . . . . . . . . . . 25 252,000 51 Volume Decrease Losses Increase 381 . . . . . . . . . . — -0- — 286 . . . . . . . . . . 25% $ 50,150 Infinite† 215 . . . . . . . . . . 25 87,125 75% 161 . . . . . . . . . . 25 115,475 32 121 . . . . . . . . . . 25 136,475 18 *First 25 percent change not exactly equal due to rounding. †Infinite because the base is zero. hel78340_ch06.qxd 9/27/01 11:13 AM Page 199 200 Financial Analysis: Tools and Techniques Effect of Lower Prices Up to this point, we’ve concentrated on cost effects which are largely under man- agement’s control. In contrast, price changes are for the most part dependent on the firm’s competitive environment. As a result, price changes normally affect the competitive equilibrium and will directly influence the unit volume a business is able to sell. Thus, it’s not enough to trace the effect of raised or lowered prices on the break-even chart, but we also must anticipate the likely impact on volume resulting from the price change. In other words, raising the price could more than proportionally affect the unit volume the company will be able to sell competi- tively, and the price action could actually result in lower total profits. Conversely, lowering the price could more than compensate for the lost contribution per unit by significantly boosting the total unit volume that can be sold against competition. Figure 6–4 demonstrates the effect of lowering the price by $50 per unit, a 6.7 percent reduction. Note that this change raises the required break-even volume by about 11 percent, to 444 units. In other words, the company needs to sell an additional 44 units just to recoup the loss in contribution of $50 from the sale of every unit. For example, if the current volume was 800 units, with a contribution of $400,000 and a profit of $200,000, the price drop of $50 per unit would require the sale of enough additional units to recover 800 times $50, or $40,000. The new units required will, of course, provide the lower per-unit contribution of $45 Under these conditions, as many as 89 additional units ($40,000 Ϭ $450) have to be sold at the lower price to maintain the $200,000 profit level, which rep- resents a volume increase of 11 percent. Note that this results in a more than pro- portional change in unit volume (11 percent) versus the drop in price (6.7 percent). Price changes affect internal operating results, but they could have an even more pronounced and lasting impact on the competitive environment. If a more than proportional volume advantage—and therefore improved profits—can be obtained over a significant period of time after the price has been reduced, this could change the competitive situation to the company’s advantage. Otherwise, if price reductions can be expected to be quickly matched by other competitors, the final effect could simply be a drop in profit for everyone, because little if any shift in relative market shares would result. The airline price wars mentioned earlier are a prime example of this phenomenon. This isn’t the place to discuss the many strategic issues involved in pricing policy; the intent is merely to show the effect of this important factor on the operating area of the business system and to provide a way of analyzing likely conditions. Multiple Effects on Break-Even Conditions Up to now, we’ve analyzed cost, volume, and price implications and their impact on profit separately. In practice, the many conditions and pressures encountered hel78340_ch06.qxd 9/27/01 11:13 AM Page 200 [...]... 10% 10 10 — $55.00 0% 0 0% 0 $60 .50 $ 40.00 $ 46. 40 0 0 $ 40.00 $ 46. 40 $53.82 $20.00 $21 .60 $23.33 $55.00 $60 .50 $ 80.00 $ 92.80 $107 .64 $40.00 $43.20 $ 46. 66 $60 .50 31.00 $ 40.00 25.00 $ 46. 40 30.00 $ 53.82 36. 00 $40.00 25.00 $43.20 27.00 $ 46. 66 29.00 10% 10 10 10 10% 10 10 10 8% 16 16 — †Profits after interest and taxes related to net assets, as often shown in financial reports ‡Growth in recorded... 8% 16 16 16 70.20 75 .66 21 .60 _ 23.33 _ 45.00 20.00 48 .60 21 .60 52.33 23.33 $65 .00 $70.20 $75 .66 8% 16 8 — 8% 16 8 8 8% 16 8 8 213 *This exhibit is available in an interactive format (TFA Template)–see “Analytical Support” on p 222 **Profits before interest, after taxes related to net assets (capitalization) as a measure of operational return on assets 8% 16 16 16 65.00 20.00 _ Page 213 $60 5.0... hel78340_ch 06. qxd Financial Growth Model Results of Three Different Policies Held Constant over Three Periods* ($ thousands) CHAPTER 6 Dynamics and Growth of the Business System F I G U R E 6 9 hel78340_ch 06. qxd 214 9/27/01 11:13 AM Page 214 Financial Analysis: Tools and Techniques only $65 ,000 This figure is lower than in the other two cases, because of the combined impact of a high dividend payout and the... increase hel78340_ch 06. qxd 9/27/01 11:13 AM Page 208 208 Financial Analysis: Tools and Techniques F I G U R E 6 7 XYZ CORPORATION Impact of Leverage on Earnings and Distribution ($ thousands) Debt Proportion 0 50 75 Total capital $2,000 $2,000 $2,000 EBIT @ 30% of capital Interest expense @ 8% and 10% 60 0 0 60 0 80 60 0 150 Income before... Year 3 Year 4 Year 5 33.3% 43.0% 43.0% 50.0% 50.0% $300.0 $ 470.7 $ 492.5 $ 68 8.9 $ 728.5 60 0.0 62 4.0 65 2.9 68 8.9 728.5 $900.0 $1,094.7 $1,145.4 $1,377.8 $1,457.0 8% $ 72.0 $ 4% $ 12.0 $ 7% 76. 6 $ 4% 18.8 $ 8% 8% 9% 91 .6 $ 110.2 $ 131.1 4% 4.5% 4.5% 19.7 $ 31.0 $ 32.8 $ 60 .0 $ 57.8 71.9 60 % $ 36. 0 $ 50% 28.9 $ 50% 35.9 $ 50% 39 .6 $ 40% 39.3 Reinvestment of profit Financing (next year): New... approach to the needs and policies of a sample company and developed an integrated financial plan with which we tested the impact of planned changes in various key policies on the company’s growth and performance hel78340_ch 06. qxd 9/27/01 11:13 AM 222 Page 222 Financial Analysis: Tools and Techniques In the end, the key test of financial analysis is the viability of the methods and results as predictors... used singly as an overall standard, of course In fact, the strong emphasis in recent years on shareholder value creation and total shareholder return achieved has put many of the accounting-based measures into a secondary role As we’ll discuss and demonstrate in more detail in hel78340_ch 06. qxd 9/27/01 11:13 AM 210 Page 210 Financial Analysis: Tools and Techniques Chapters 11 and 12, shareholder value... with more tenable assumptions and calculate the impact of such changes Basic planning frameworks of this kind are fairly easy to construct on spreadsheets, while more inclusive financial models can be programmed to provide output of this kind hel78340_ch 06. qxd 9/27/01 11:13 AM Page 218 218 Financial Analysis: Tools and Techniques F I G U R E 6 10 XYZ CORPORATION Integrated Financial Plan:* Sample Five-Year... assumption to make production and sales simultaneous doesn’t necessarily hold true in practice; the normal lag between production and sales has a significant effect In a manufacturing company, sales and hel78340_ch 06. qxd 9/27/01 11:13 AM Page 202 202 Financial Analysis: Tools and Techniques production can be widely out of phase Some of the implications of this condition were discussed in Chapter 3, when we dealt... obtainable tax savings and the cash flow implications from financial stress and even failure The “right” level of leverage will differ greatly among companies, industries, and management styles hel78340_ch 06. qxd 9/27/01 11:13 AM Page 209 CHAPTER 6 Dynamics and Growth of the Business System 209 Finding the optimal degree of leverage for a business requires a careful assessment of potential financial risks, . D I E hel78340_ch 06. qxd 9/27/01 11:13 AM Page 205 2 06 Financial Analysis: Tools and Techniques When we apply the formula to one set of conditions that pertained to Figure 6 6, the results can. secondary role. As we’ll discuss and demonstrate in more detail in hel78340_ch 06. qxd 9/27/01 11:13 AM Page 209 210 Financial Analysis: Tools and Techniques Chapters 11 and 12, shareholder value creation. profits hel78340_ch 06. qxd 9/27/01 11:13 AM Page 197 198 Financial Analysis: Tools and Techniques at current levels and influence the movement of the break-even point itself. In Fig- ure 6 3, we’ve shown