2. Types of leverage
1. Operating leverage :-
Operating leverage concerned with the cost structure
of a firm
The change in operating profits after changing fixed cost is
greater than the percentage change in sales ,is known as
operating leverage
Operating leverage can be determined by means of break –
even analysis or cost-volume profit analysis at any level of
sales in term of total sales
contribution (sales –variblecost)
Operating leverage = operating profit
3. Example : - calculate operating leverage from the
following information interest 5000,sales
50,000,variable cost 25000,fixed cost 15000
sales-variable cost
operating leverage= EBIT
EBIT= sales-variable cost-fixed cost
50000-25000-10000 = 15000
= 50000-25000
15000
4. Financial leverage
Financial leverage knows as trading or equity it
defined as the the ability of a firm to use fixed
financial charges to magnify the effects of changes in
ebit on earnings per share
EBIT
Financial leverage = PBT
5. Example : - a company has the following capital
structure
equity share capital 100,000
10%preference share capital 100000
8% debetntures 125000
Solution
Operating profit or EBIT 50000
Less: interest on debenture 10000
Pref.dividend(per-tax basis) 10000
total 30000
