DIFFERENCE BETWEEN OPERATING LEVERAGE AND FINANCIAL LEVERAGE

Sr Parameter Operating leverage Financial leverage

No
1. What is it? Operating leverage refers to the percentage of Employment of fixed financial charges bearing funds
fixed costs that a company has. If a business firm in a company’s capital structure is known as Financial
has a lot of fixed costs as compared to variable Leverage.
costs, then the firm is said to have high operating
leverage.

2. Which side Operating leverage refers to the asset side of the Financial leverage refers to the liability side of the
of BS balance sheet balance sheet

3. Formula Operating Leverage Financial Leverage

= Contribution / EBIT = EBIT / EBT

4. Measurement The Operating Leverage measures the effect on Financial Leverage measures the effect on profit of
of profits of fixed operating costs interest expenses

5. Effect Operating leverage delineates the effect of change Financial leverage reflects the change in EBIT on
reflection in sales on the company’s operating earnings EPS level

6. Impacting Operating leverage magnifies the returns from plant Financial leverage magnifies the returns from debt
factors and equipment or fixed assets financing

7. Influences Operating leverage influences the top half of the Financial leverage influences the bottom half of the
what? income statement and operating income, income statement and the earnings per share to the
determining return from operations stockholders

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Sr Parameter Operating leverage Financial leverage
No
8. Role of In the case of operating leverage, fixed expenses Financial leverage increases the minimum
leverage extend the break-even point for a business requirement of operating profits to meet with the
expense of interest.

9. Business The operating leverage for a capital intensive firm, The financial ratios we use in determining the amount
pattern would be high, while the operating leverage for a of financial leverage we have in a business firm is
influencing labour intensive firm would be lower the debt / equity ratio. The debt/equity ratio shows the
leverage proportion of debt in a business firm to equity

10. If a firm has high operating leverage, a small The use of financial leverage, or debt, in financing a
What if the change in sales volume results in a large change in firm's operations, can really improve the firm's return
leverage is EBIT and ROIC, return on invested capital. on equity and earnings per share.
high?
In other words, firms with high operating leverage This is because the firm is not diluting the owner's
are very sensitive to changes in sales and it affects earnings by using equity financing
their bottom line quickly.

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