Leverage Analysis

Lever or leverage is the use of fix costs and debts to magnify

the returns of the business.
Types of leverage:
1. Operating leverage: The use of operating costs to magnify
the returns of the business
2. Financial leverage : The use of financing to magnify the
returns of the business
 Income statement
FY 2018 FY 2019 Changes (%)
Sales 25000 30000 (Sales – Sales )/ Sales
2019 2018 2018

{(30000-25000)/25000} x100

= +20%

Less CGS
Gross Profit
Less Operating
Expenses
EBIT 5000 5200 (EBIT 2019 – EBIT2018)/ EBIT2018

[(5200-5000)/5000]x100
= +4%
Less Interest
EBT
Less Taxes
EAT
EPS 1.2 1.35 (EPS – EPS )/ EPs
2019 2018 2018

[(1.35-1.2/1.2]x 100
+12.5%
EPS = EAT/ no of
share of common
stock outstanding

From Sale to EBIT --------- operating leverage

From EBIT to EAT or EPS -------------- Financial Leverage
Measurement of Leverage
1. Degree of Operating leverage: DOL : The numerical
measure of operating leverage is called DOL
DOL = %Change in EBIT/ %change in Sales
If DOL > 1 then operating leverage exist, the higher the
value of DOL higher the operating leverage

DOL is used as proxy or measure of operating risk or

business risk as well: If a firm is unable to pay its
operating cost then it is called that operating risk exist
which we have to eradicate or minimize:

DOL = % change in EBIT/ % change in Sales

DOL = +4% /+20%
DOL = 0.2
DOL < 1 so operating leverage does not exist
Degree of Financial Leverage DFL

The numerical measure of financial leverage is called

Degree of Financial leverage: DFL is used as proxy or
measure of financial risk as well: If a firm is unable to
pay its financial cost then it is called that financial risk
exist: we have to manage or diversify this risk as well:

DFL = % change in EPS/ % change in EBIT

DFL = 12.5%/ 4% = 3.125
DFL > 1 it means financial leverage exist:
Degree of Total Leverage

DTL measures the overall leverage

DTL = DOL x DFL
DTL = 0.2 x 3.125 = 0.625
DTL = % change in EPS / % change in Sales
DTL = 12.5%/20% = 0.625

TOTAL RISK = operating risk + Financial Risk

What is Cost:
Cost is an unexpired expense:
Expense is an expired portion of cost:

Costs : Fixed cost and Variable Cost

Fixed Cost: Fixed cost remains fix in total but varies
per unit:
27000/27 = 1000
27000/ 20 = 1350

Variable Cost : Variable cost remain vary in total but

remain fix per unit
100x 5 = 500
100x7 = 700

Break even point = BEP is that point at which no profit

and no loss
BEP = FC/( p-vc)
FC = 2500
Price per unit = Rs 10
Vc per unit = 8
BEP = 2500/ (10-8)
BEP = 1250

Contribution Margin = (Sales Revenue – Variable Cost)