LEVERAGE

An increased means for

accomplishing some purpose
 Leverage helps us in lifting heavy objects,
which may not be otherwise possible
 The term leverage is used to describe the
firm’s,ability to use fixed cost assets or
funds to magnify the returns to its owners.
 Types of leverage

 Operating leverage
 Financial leverage
 Combined leverage
 Operating leverage: it relates to the sales
and profit variations.
 Operating leverage is the firm’s ability to
use the fixed operating costs to magnify the
effects of changes in sales on its earning
before interest and tax.
 Degree of Operating leverage=contribution
/EBIT
 Financial leverage: it indicates the effects
on earnings due to rise of fixed cost funds.
 Financial leverage is the ability of the firm
to use fixed financial charges to magnify
the effect of change in earnings per share.
 Degree of financial leverage=EBIT/EBT
 Combined leverage:
 It is combination of both leverage.
 Degree of combined
leverage=contribution\EBT
 Importance of leverage:
 It helps in examining a relative change in the
profits due to changes in sales.
 It helps in bifurcating the fixed costs into fixed
operating costs and fixed financial costs and thus
examine its impact on the profits of the firm at
differently.
 Leverage helps in determining the EPS of the
company.
 Margin of safety :it is the excess sales over
the Break-Even Sales. It is the difference
between actual sales and Break-even sales.
 Break Even analysis: it indicates at what
level costs and revenue are in equilibrium