Leverage Analysis In Financial Management Leverage is the burden which arises with the presence of fixed cost in business If a business is leveraged , it means that the firm has borrowed money to finance the purchase of assets With larger presence of fixed cost profit margins can really get squeezed when the business scenario is not favorable and the sales fall. This adds risk to the stocks of such companies Conversely, with the same larger presence of fixed cost company would experience magnified profits with increase in sales as the cost level remaining constant Operating Leverage- It arises with the presence of firm’s fixed operating costs such as salaries, rent, depreciation, utility expense etc. Financial Leverage- It arises with the presence of firm’s fixed financing costs such as interest expenses on debt and preference shares Combined Leverage- Product of operating and financial leverage Formulas for calculation of leverages- Operating Leverage = Contribution / EBIT Operating Leverage = % change in EBIT/ % change in sales Financial Leverage = EBIT/ EBT Financial Leverage = % change in EPS / % change in EBIT Combined Leverage = OL * FL Degree of Combined Leverage = % change in EPS / % change in Sales Thank you for watching Subscribe to my channel DevTech Finance

1. LEVERAGE
ANALYSIS
FINANCIAL MANAGEMENT

2. INTRODUCTION
• Leverage refer to the amount of debt a firm uses to finance
assets
• It arises from the existence of fixed costs
• It is an investment strategy to use borrowed money
• If a business is leveraged , it means that the firm has
borrowed money to finance the purchase of assets

3. CONTINUED
• With larger presence of fixed cost profit margins can really
get squeezed when the business scenario is not favorable
and the sales fall. This adds risk to the stocks of such
companies
• Conversely, with the same larger presence of fixed cost
company would experience magnified profits with increase
in sales as the cost level remaining constant

4. MAGNIFICATION EFFECT WITH THE
PRESENCE OF FIXED COST
Case 1 Case2 Case 3
Revenue 15 lacs 21 lacs 12 lacs
- Fixed Cost -10 lacs -10 lacs -10 lacs
= Profit =5 lacs =11 lacs =2 lacs
% Change in Revenue =
Case2 (21-15)/15 * 100 = 40% Case3 (12-15)/15*100 = -20%
% Change in Profit =
Case2 (11-5)/5 * 100 = 120% Case3 (2-5)/5* 100 = -60%

5. TYPES OF LEVERAGE
1. Operating Leverage- It arises with the presence of firm’s fixed
operating costs such as salaries, rent, depreciation, utility expense
etc.
2. Financial Leverage- It arises with the presence of firm’s fixed
financing costs such as interest expenses on debt and preference
shares
3. Combined Leverage- Product of operating and financial leverage

6. FORMULAS
Sales – Variable cost = Contribution
Contribution – Fixed cost = Earning before interest and tax
Earning before Interest and tax – Interest = Earning before Tax
Earning before tax – Tax = Earning after Tax
Earning per share = Earning after Tax / No. of Shares

7. FORMULA
• Degree of Operating Leverage = Contribution / EBIT
• Degree of Operating Leverage = % change in EBIT/ % change in sales
• Degree of Financial Leverage = EBIT/ EBT
• Degree of Financial Leverage = % change in EPS / % change in EBIT
• Degree of Combined Leverage = OL * FL
• Degree of Combined Leverage = % change in EPS / % change in Sales

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