Financial Management - Leverage For Academics Use For Any queries please contact the email id mentioned in file

1. For Academics krishna.khandelwal2010@yahoo.com
Leverage
Leverage is the tool which make our work easier
Higher Leverage – less Effort and more Output
Lower leverage – more Effort and less Output.
Operating leverage
Operating leverage arises through Cost structure .Fixed cost is an operating leverage
In any business in which fixed cost are high, we will call that company posses High leverage.
Example of High Operating leverage companies
 In Airline business , Fixed cost are high , Variable Cost are Fuel Charge (it depends)
 If DOL = 3 what does this mean?
If sales is increased by +30% then Operating profit is increased by +60%
If sales is decreased by -30% then Operating profit is increased by -60%
 If operation are going well then the company is performing well. (Do well in boom markets)
 Trouble in time of recession because of high operational risk (like in 2008 crisis)
 High Operating leverage  High Operational Risk
Example of low Operating leverage companies
 IT companies ,
 less fixed cost (like Rent , Utilities)
 High Variable cost (like Salaries )
 Business can cut variable costs as per market conditions . ( In Recession ,Laying off employee and If Dollar is
Strong , hiring more employee)
 Low Operating leverage  low Operational Risk
Formula
DOL = Contribution/EBIT
DOL = % Change in EBIT / % Change in Sales

2. For Academics krishna.khandelwal2010@yahoo.com
Financial leverage
Financial leverage arises through Capital structure. Depend on portion of Debt and Equity is financial leverage.
If the loan amount is high that means business is using someone else money business is putting less effort and they can get
more output . Hence, company posses high financial leverage.
Example of High Financial leverage companies
 In Real Estate ,Companies usually Take loan to build Flat. They take loan from Bank and make, due to which
they make good returns.
 If ROI > Interest : Company can grow very Fast.(under good market condition)
 Let assume ROI (Return on Investment is 15% ) and bank gave loan at 12% .This means Company is earning 3%
profit
 If ROI < Interest : Company may not grow Fast.(under bad market condition)
 High Financial leverage  Higher Solvency Risk ( higher chance of Bankruptcy)
Example of low Financial leverage companies
 In IT Companies or Product development, they have zero or low debt
 Companies can survive with low ROI as well
 Interest = 0
 ROI = 6%
 Any way you are making profit.
Formula
DFL = EBIT/PBT
DFL = % Change in EPS / % Change in EBIT