emphasis on types of leverages

1. BEN SAJI

2. MEANING
Leverage is an investment technique in which you use a
small amount of your own money to make an
investment of much larger value. In that way, leverage
gives you significant financial power.

3. There are 3 types of leverages Viz;
1. Operating Leverage
2. Financial Leverage
3. Composite Leverage
The leverage associated with the employment of fixed cost asset is
referred to as operating leverage, While the leverage resulting from
the use of fixed cost/return source of fund is known as financial
leverage. Composite leverage focus on the entire income of the
concern.
TYPES OF LEVERAGES

4. • Operating leverage may be defined as the tendency of the
operating profit(EBIT) to vary disproportionately with sales.
Operating leverage is said to exist when a firm has to pay fixed
cost regardless the volume of output or sales.
• Operating leverage in a firm is a function of 3 factors
1. The amount of Fixed cost
2. The Contribution margin (S-V)
3. The volume of sales
OPERATING LEVERAGE

5. OPERATING LEVERAGE
Operating Leverage = Contribution
EBIT
Degree of OL = % Change in profits
%change in sales

6. Financial leverage may be defined as the tendency of the residual net income (PBT) to vary
disproportionately with operating profits (EBIT).
It indicates the change that takes place in the taxable income as a result of a change in the
operating income.
It signifies the existence of fixed interest and or fixed dividend bearing securities in the total
capital structure of the company.
In other words the use of fixed interest or dividend bearing securities such as debt and preference
capital along with the owners equity in the total capital structure of the company is defined as
financial leverage
Financial leverage

7. Financial leverage = Operating Profit(EBIT)
Taxable Income (PBT)
Degree of FL = % change in taxable income
% change in operating profit
FINANCIAL LEVERAGE

8. • Combined leverage is the leverage obtained by combining operating leverage and
financial leverage. Composite leverage discloses the effect of change in sales on
taxable profit ie; EPS
• Composite leverage expresses the relationship between revenue on account of sales
(ie; contribution) and taxable income. It helps in finding out the percentage change in
taxable income on account of percentage change in sales.
COMBINED LEVERAGE/ COMPOSITE LEVERAGE

9. Combined leverage = Operating Leverage * Financial Leverage
Contribution
PBT
COMBINED LEVERAGE