This document introduces the concepts of financial leverage, operating leverage, and total leverage. It defines leverage as employing assets or funds where a firm pays fixed costs or returns. Leverage causes profits to change at a faster rate than sales. Operating leverage is related to fixed costs and how changes in sales impact operating income. Financial leverage depends on the ratio of debt to common shares and is calculated using EBIT and EBT. Combined leverage multiplies operating and financial leverage to assess their combined impact. The document discusses operating leverage in further detail and how it is related to fixed costs and the level of fixed assets used.
In general, leverage refers to accomplish certain things which are otherwise not possible
i.e. lifting of heavy objects with the help of lever. This concept of leverage is valid in business also.
In finance, the term ‘leverage’ is used to describe the firm’s ability to use fixed cost asset or funds to increase the return to its owners; i.e. equity share holders. In other words, the fixed cost funds i.e. debentures & preference share capital act as the fulcrum, which assist the lever i.e. the firm to lift i.e. to increase the earnings of its owner i.e. the equity shareholders.
Leverage is also the influence which an independent variable has over a dependent/related variable i.e. rainfall over production. In financial context, sales& fixed cost over profit.
In general, leverage refers to accomplish certain things which are otherwise not possible
i.e. lifting of heavy objects with the help of lever. This concept of leverage is valid in business also.
In finance, the term ‘leverage’ is used to describe the firm’s ability to use fixed cost asset or funds to increase the return to its owners; i.e. equity share holders. In other words, the fixed cost funds i.e. debentures & preference share capital act as the fulcrum, which assist the lever i.e. the firm to lift i.e. to increase the earnings of its owner i.e. the equity shareholders.
Leverage is also the influence which an independent variable has over a dependent/related variable i.e. rainfall over production. In financial context, sales& fixed cost over profit.
Approaches to determine appropriate capital structure - EBIT-EPS Approch
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DEFINITION of 'Leverage'
1. The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment.
2. The amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged.
Leverage is most commonly used in real estate transactions through the use of mortgages to purchase a home.
Approaches to determine appropriate capital structure - EBIT-EPS Approch
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DEFINITION of 'Leverage'
1. The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment.
2. The amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged.
Leverage is most commonly used in real estate transactions through the use of mortgages to purchase a home.
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Letter from the Congress of the United States regarding Anti-Semitism sent June 3rd to MIT President Sally Kornbluth, MIT Corp Chair, Mark Gorenberg
Dear Dr. Kornbluth and Mr. Gorenberg,
The US House of Representatives is deeply concerned by ongoing and pervasive acts of antisemitic
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Biological screening of herbal drugs: Introduction and Need for
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5. LEVERAGES
OBJECTIVES
• understand the concepts of financial leverage, operating leverage and total
leverage
• explain the computation process of leverages
• assess the behaviour and applications of leverages
• analysis the relationship between EBIT and EPS
• discuss the importance of leverages
6. James Horne has defined leverage as the
employment of an asset or funds for
which the firm pays a fixed cost or fixed return.
Christy and Roder defines leverage as the
tendency for profits to change at a faster
rate than sales.
7. Essential characteristics of leverage are as follows :
(a) Leverage is applied to the employment of an asset or
funds.
(b) Profits tend to change at a faster rate than sales.
(c) There is risk return relationship which is basically found
in the same direction.
(d) If higher is the leverage, higher will be the risk and
higher will be the expected returns.
8. Operating Leverage is related to fixed cost. It
indicates the impact of changes in
sales on operating income. It is calculated as
follows: :
Contribution
---------------
EBIT
9. Financial Leverage depends upon the ratio of
debt and preferred stock together to common
shares. It is calculated with the help of EBIT
and EBT as below :
EBIT
---------------
EBT
10. Combined Leverage is the multiplication of
operating leverage and financial
leverage.
Combined Leverage = Op. Leverage and F.
Leverage
11. OPERATING LEVERAGE
It takes place when a change in revenue
produces a greater change in EBIT.
It is related to fixed costs. A firm with relatively high
fixed costs uses much of its
marginal contribution to cover fixed costs.
12. It refers to heavy usage of fixed assets.
“The use of fixed operating costs to magnify a change in profits relative to a
given change in Sales”
- Walker & Petty.
“If a high percentage of a firm’s total costs are fixed costs, then the firm is said
to have a high degree of operating leverage
- E F Brigham
13. It is a function of three factors :
Fixed costs
Contribution
Volume of Sales
