OPERATING AND FINANCIAL

LIVERAGE

PRESENTED BY
DEEPAK ANAND
ZAFAR KAMAL
OUTLINE
What is Leverage?
Break-Even (BE) Point
Operating Leverage
Financial Leverage
Leverage Means Risk
Combined or Total Leverage
WHAT IS LIVERAGE
Leverage is using fixed costs to magnify the potential
return to a firm

2 types of fixed costs:

– fixed operating costs = rent, depreciation
– fixed financial costs = investment costs from debt
BREAK-EVEN POINT
Quantity where TR= TC

No Profit or Loss

BE = Fixed Costs / (Price – Variable Costs)

A leveraged firm has a high BE point

A non-leveraged firm has a low BE point

OPERATING LIVERAGE
Measure of the amount of fixed operating costs
used by a firm

Degreeof Operating Leverage (DOL) = %age

 in EBIT / %age  in Sales

a  in Sales  a larger  in EBIT

Operating Leverage measures the sensitivity of

a firm’s operating income to a  in sales
FINANCIAL LIVERAGE
Measure of the amount of debt used by a firm

Degreeof Financial Leverage (DFL) = %age

 in EPS / %age  in EBIT

a  in EBIT  a larger  in EPS

Itmeasures the sensitivity of a firm’s earnings

per share to a  in operating income
INCOME STATEMENT
LIVERAGE MEANS RISK
Leverage is a double-edged sword

It magnifies profits as well as losses

An aggressive or highly leveraged firm has high

fixed costs (and a relatively high break-even
point)

A conservative or non-leveraged firm has low

fixed costs (and a relatively low break-even point)
 Combining Financial and
Operating Leverages
Operating leverage affects a firm’s operating profit
(EBIT), while financial leverage affects profit after tax or
the earnings per share.
The degrees of operating and financial leverages is
combined to see the effect of total leverage on EPS
associated with a given change in sales.
COMBINED OR TOTAL LIVERAGE
 Represents maximum use of leverage

 Degreeof Combined or Total Leverage (DCL or DTL) =

%age  in EPS / %age  in Sales

a  in Sales  a larger  in EPS

COMBINING
OPERATING
OR
FINANCIAL
LIVERAGE
THANK YOU