This document discusses different types of leverage used in business. There are three main types: operating leverage, financial leverage, and combined leverage. Operating leverage measures how fixed costs affect operating profit with changes in sales. Financial leverage shows how interest expenses affect net income. Combined leverage considers both operating and financial leverage and their combined impact on earnings per share with sales changes. The degree of each type of leverage can be calculated to understand the risk involved at different levels.

1. TYPES OF LEVERAGES
BY
ASWATHY JAYAN

2. LEVERAGE
‘Leverage’ means ‘effectiveness’ or ‘power’
A firm is said to be leveraged if it has fixed cost
Degree of leverage
-Measure of how much leverage the firm uses
There are three types of leverages
-Operating leverages
-Financial leverages
-Combined leverages

4. Operating leverage
 Operating leverage is a measurement of the
degree to which a firm incurs a combination
of fixed and variable cost
 Operating leverage = contribution/EBIT
contribution = sales – variable cost
EBIT = contribution –fixed cost
Note : in case the contribution exceeds the
fixed cost,the operating leverage is favorable.
when C<F, the operating leverages is
unfavorable

5. Degree of operating leverage
 It measures how muchis the effect of change in
sales on operating profit.
 The degree of operating leverage at any level is
expressed in percentage change in operating profit
to percentage change in sales
 Degree of operating leverage= % change in EBIT
% change in sales

6. Importance of operating
leverages
 Profit planning
 Capital structure planning
 Risk analysis

7. Financial leverage
 It is the tendency of the residual net income
to vary disproportionately with the operating
profit. It indicate the changes that takes place
in the taxable income as a result of the
change in the operating profit.
 Financial leverage= EBIT
EBT
EBIT= Earning before interest and tax
EBT= I-EBIT , ie earning before tax
I = interest and preference divident

8. Degree of financial leverage
 The degree of financial leverage is defined as
the percentage change in EPS due to the
given percentage change in EBIT.
 DFL = % change in EPS
% change in EBIT

9. Limitations of financial
leverages
 Increases risk
 Beneficial only to companies having stable
earning
 Restrictions from financial institutions

10. Difference between Operating leverage
& Financial Leverage
 It establishes the
relationship b/w
operating profit & sales
 It influence EBIT
 It is concerned with
investment decision
 It explains business risk
of the firm
 It is the first stage
leverage
 It establishes the
relationship b/w operating
profit & rate of equity
 It affect EAT
 It is concerned with finance
decision
 It deals with financial risk of
the firm
 It is the second stage
leverage

11. Combined or Total leverage
 It is the combination of operating and
financial leverage
 Both of these leverage are closely concerned
with firms capacity to meet its fixed cost &
their combined effect will measure the firms
financial strength.
 Combined leverage = operating leverage *
financial leverage

12. Degree of combined leverage
 It is calculated by multiplying the DOL and
the DFL and it is calculated by the formula
 Degree of combined leverage
=DOL * DFL
ie,= % change in EPS
% change in sale