Types of Leverages Operating leverage arises from the existence of fixed operating costs such as salary, rent, utilities etc. A company with high fixed cost and low variable cost has high operating leverage whereas, a company with low fixed cost and high variable cost has low operating leverage. Operating leverage magnifies both profit as well as loss . When the sales increases profit will be magnified, when the sales decreases loss also will be magnified. Financial leverage is the degree to which a company uses fixed interest expense securities such as debt and preference shares The more debt financing a company is in higher financial leverage. A high degree of financial leverage means high interest payments which negatively affect the company's bottom line earnings per share Degree of operating leverage will tell how much is the risk related to the operating activities Degree of financial leverage will tell how much is the risk related to the financial activities Combined leverage takes into consideration the overall leverage including operating and financial leverage Formulas- 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 Thank you for watching Subscribe to DevTech Finance for more videos.

1. TYPES OF LEVERAGE
FINANCIAL MANAGEMENT

2. TYPES OF LEVERAGE
Operating
Leverage
Financial
Leverage
Combined
Leverage

3. 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

4. FORMULAS
• 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

5. NUMERICAL EXAMPLE – CALCULATE DEGREE OF
OPERATING, FINANCIAL AND COMBINED LEVERAGES
Particulars Values
Units 50000
Fixed Cost $10000
Variable cost per unit $ 0.20
Interest Expense $ 2000
Selling Price per unit $ 0.50

6. SOLUTION
• Sales = No. of units * Selling price per unit
 50000* 0.50 = $25000
• Variable cost = No. of units * Variable cost per unit
 50000*0.20 = $10000

7. DEGREE OF OPERATING LEVERAGE
• Degree of Operating Leverage = Contribution / EBIT
• Contribution= Sales – Variable Cost= 25000-10000=15000
• EBIT= Sales – (Variable cost + Fixed cost) = 25000-
(10000+10000) = 5000
• DOL= 15000 / 5000 = 3

8. DEGREE OF FINANCIAL LEVERAGE
• Degree of Financial Leverage = EBIT/ EBT
• EBIT = 5000
• EBT = EBIT – Interest Expenses= 5000- 2000=3000
• DFL= 5000/3000 = 1.67

9. DEGREE OF COMBINED LEVERAGE
• Degree of Combined Leverage = DOL * DFL
• DCL= 3 * 1.67 = 5.01
Interpretaion- The business is more leveraged because of the
presence of fixed operating cost where the degree of
operating leverage is 3, higher as compared to the financial
burden of 1.67

10. USING THE PERCENTAGE FORMULA
• Suppose with the same data given if you are required to find-
1. % change in EPS if EBIT increases by 5%
2. % change in EBIT if sales increases by 10%
3. % change in EPS if sales increases by 10%

11. SOLUTION
1. Degree of Financial Leverage = % change in EPS / % change in EBIT
=> % change in EPS = DFL * % change in EBIT = 1.67 * 5 = 8.35%
2. Degree of Operating Leverage = % change in EBIT/ % change in sales
=> % change in EBIT = DOL* % change in sales = 3 * 10 = 30%
3. Degree of Combined Leverage = % change in EPS / % change in Sales
=> % change in EPS = DCL * % change in Sales = 5.01 * 10 = 50.1%

12. THANK YOU FOR WATCHING
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