FINANCIL LEVERAGE, OPERATING LEVERAGE , COMBINED LEVERAGE

8/7/2019 FINANCIL LEVERAGE, OPERATING LEVERAGE , COMBINED LEVERAGE

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Contend` Meaning` Financial leverage` Operating leverage` Combine leverage

` Risk of leverage


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Leverage

` Leverage has been defined as "the action of alever is , and mechanical advantage gained by

it.` Leverage is the means which a business firm

can increase the profits. The force will be

applied on debt, the benefit of this reflected inthe form of higher returns to equityshareholders.


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Master table to calculate the leverage

P articulars Amount(Rs)Sales xxxxless: variable cost xxx

Contribution XXXLess: Fixed cost xxxEarning before Interest and tax xxxLess: interest xxxEarning before tax xxxLess: tax xxx

Earning after tax xxxLess: P reference dividends xxxEarning available for equity share holder xxx


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Financial leverage

Financial leverage is a tool with which a financial manager canmaximize the returns to the equity shareholders.Financial leverage signifies the relationship between the earningpower on equity capital and rate interest on borrowed capital.Financial leverage helps the finance manager to select anappropriate mix of capital structure. Capital is required for thepurpose of meeting both long-term & short-term financial

requirement of a business unit. This could be raised throughlong term as well as short term sources, namely, Equity shares,debentures, preference shares, public deposits.


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Formulas

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Operation leverage

` The operation leverage has a bearing on fixed costs. There isa tendency of the profits to change, if the firm employsmore of fixed cost in its production process, greater will bethe operating cost irrespective of the size in its production.The operating leverage will be at a low degree when fixedcosts are less in the production process. Operating leverageshow the ability of a firm to use fixed operating cost toincrease the effect of change in sales on its operating profits.


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Formulas


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Combined leverage

` This leverage shows the relationship between achange in sale & the corresponding variation in

taxable income. If the management feels that acertain percentage change in sale would result inpercentage change to taxable income they wouldlike to know the level or degree of change & hencethey adopt this leverage.


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Formulas

` R epresents maximum use of leverage` Degree of Combined or Total Leverage

(DCL or DTL) = %age in EPS / %age in Sales

` a in Sales p a larger in EPS` Short-cut formula:

DCL or DTL = DOL x DFL


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Leverage Means Risk

` Leverage is a double-edged sword` It magnifies profits as well as losses` An aggressive or highly leveraged firm has high fixed costs

(and a relatively high break-even point)` A conservative or non-leveraged firm has low fixed costs

(and a relatively low break-even point)

` Many Japanese firms tend to be highly leveraged


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Documents

FINANCIL LEVERAGE, OPERATING LEVERAGE , COMBINED LEVERAGE