Leverage Analysis Techniques

Leverage Analysis The dictionary meaning of the term leverage refers to “ an increased means of accomplishing purpose.” In mechanics, leverage means the instrument that helps us in lifting heavy objects, which may not be otherwise possible. In financial management, the firm’s ability to use fixed cost funds to magnify the return of its owners . The use of the fixes charge sources of funds, such as debt and preference capital along with the owner’s capital in the capital structure is described as financial leverage.

[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

[object Object],[object Object],[object Object],[object Object],[object Object]

[object Object],[object Object]

[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

We conclude that the degree of operating leverage increases with every increase in share of fixed cost in the total cost structure of the firm. It shows for e.g., in situation 3 that if sales increase by one percent, the profit would increase by 4%. This can be verified by placing suitable figure in situation 3 suppose sales is Rs.8,000 i.e., 100% increase than the operating profit will be Rs.2,000 which is increased by 400%. Particulars Situation Situation Situation 1 2 3 ,[object Object],Rs. 4,000 Rs. 4,000 Rs. 4,000 (ii) Variable Cost 2,400 2,400 2,400 (iii) Contribution (i -ii) 1,600 1,600 1,600 (iv) Fixed Cost 400 1,000 1,200 (v) Operating Profit (iii - iv) 1,200 600 400 (vi) Operating Leverage (C/OP) (1,600/1,200) = 1.33 (1,600/600) = 2.67 (1,600/400) = 4

[object Object],[object Object],[object Object]

[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],Particulars Amount Rs. Operating Profit (OP) 50,000 Less: Interest on Debenture @ 8% 10,000 Preference Dividend (Pre – tax basis) 20,000 (-) 30,000 Profit before tax (PBT) 20,000 Financial Leverage = OP/PBT 50,000/20,000 = 2.5

Leverage Analysis Techniques

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Viewers also liked

Viewers also liked (6)

Similar to Leverage Analysis Techniques

Similar to Leverage Analysis Techniques (20)

Recently uploaded

Recently uploaded (20)

Leverage Analysis Techniques