Bba education management Module IV- Leverage.pdf

Education management bba

1. LEVERAGE
BY: DR. ANUPAM JAIN

2. Meaning
ThetermLeverageisusedforatechniquebywhichmore
weightisraisedwithlesspower.InFinancialManagement,
theleverageistherewhereisfixedcost.Ifanyfirmisusing
somepartoffixedcostcapitalthenthefirmhasleverage
whichcanbeusedforraisingprofitabilityandfinancial
strengthofthefirm.
Leverageisusedinthesensethataslightchangeinsales
resultsinarelativelyhigherchangeinprofits.Itisonly
possiblewhenfixedcostcapitalisusedalongwithequity
capital.Thisindicatedthatfixedcostsarethemainbasisof
leverageandplayanimportantroleinincreasingtheprofits
atafasterrate.

3. Types of Leverage
Operating
Leverage Financial
Leverage

4. Operating Leverage
Ifthefirmisbearingsomefixedcostsorexpenseswhicharenot
relatedtoproductioncapacity,thefirmhasOperatingLeverage.If
therearefixedcostsinthefirmandthefirmvariesitsproduction
thentheincreaseinproductionwillleadtohigherincreaseinthe
rateofprofitandthiscanbeknownwiththehelpofOperating
Leverage.Thuswecansaythat:
1.Itisrelatedtofixedcost.
2.RelatedwithdebitsideofP&L.
3.NearBEPpointOLishighest.
4.Itcariesbusinessrisks.
5.WhendegreeofOLishigher,itdepictsmoreoperatingriskfor
thefirmorviseversa.

5. Income Statement
Particulars Amount in `
Sales (S) XXXXX
Less: Variable Cost (V) XXXXX
Contribution(C) XXXXX
Less: Fixed Cost (F) XXXXX
Earning Before Interest & Tax (EBIT) XXXXX
Less: Interest (I) XXXXX
Earning Before Tax(EBT) XXXXX
Less : Tax XXXXX
Earning After Tax (EAT) XXXXX

6. Computation of Operating Leverage
OperatingLeveragecanbecomputedatanylevelof
saleswiththehelpoffollowingEquation:
Degree of Operating Leverage:
DOL is calculated when two or more level of sales given in
the question. It can be calculated as below:
OL =
�
��??????�
Or
�−??????
�−�
DOL =
% �ℎ???????????????????????? ???????????? ��??????�
% �ℎ???????????????????????? ???????????? �??????????????????�

7. Financial Leverage
If the firm is bearing fixed cost bearing capital in its Capital
Structure, the firm has Financial Leverage. This may be
defined as the ability of the firm to use fixed cost of capital
to magnify the effect of changes in operating profit 0r
EBIT. Thus we can say that:
1.It is related to fixed cost Capital.
2.Related with liabilities of Balance Sheet.
3.Shows effects of changes in fixed cost on EPS of firm.
4.It caries financial risks.
5.When degree of FL is higher, it depicts more financial
risk for the firm or vise versa.

8. Computation of Financial Leverage
Financial Leverage can be computed at any level of sales with
the help of following Equation:

Degree of Financial Leverage:
DFL is calculated when two or more level of sales given in the
question. It can be calculated as below:
FL =
��??????�
���
or
��??????�
��??????�−??????
or
��??????�
��??????�−??????−??????�\i−�
DFL =
% �ℎ???????????????????????? ???????????? ���
% �ℎ???????????????????????? ???????????? ��??????�
or
% �ℎ???????????????????????? ???????????? �??????�
% �ℎ???????????????????????? ???????????? ��??????�

9. Computation of Combined Leverage
Financial Leverage can be computed at any level of sales
with the help of following Equation:

Degree of Combined Leverage:
DFL is calculated when two or more level of sales given in
the question. It can be calculated as below:
CL =
�
���
or OL X FL
DCL =
% �ℎ???????????????????????? ???????????? ���\EPS
% �ℎ???????????????????????? ???????????? �??????????????????�
or DOL X DFL

10. Difference between Operating &
Financial Leverage
S.
No.
Basis of
Difference
Operating
Leverage
Financial
Leverage
1 Meaning OL can be defined as firms’
ability to use fixed cost to
generate more returns
FL can be defined as firms’ ability
to use capital structure to earn
better returns.
2 About Its’ about the fixed cost of the
firm.
Its’ about the capital structure of
the firm.
3 Measurement OL measures the operating risk
of the firm.
FL measures the financial risk of
the firm.
4 Formula OL = C\EBIT FL = EBIT\EBT
5 Impact When degree of OL is higher, it
depicts more operating risk for
the firm or vice versa.
When degree of FL is higher, it
depicts more financial risk for the
firm or vice versa.
6 Relation with It is related with debit side of P
& L a/c.
It is related with liabilities side of
Balance Sheet.

11. Example 1:

12. Solution 1:

13. Solution 1 continues…

14. Example 2:

15. Solution 2:

16. Example 3:

17. Solution 3:

18. Solution 3 continues…

19. Example 4 :

20. Solution 4: