Leverage - Financial, Operating and Combined
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Leverage refers to assets or sources of finance that a firm uses which require fixed payments. There are three types of leverage: operating, financial, and combined. Operating leverage is caused by fixed operating expenses and measures how changes in sales impact earnings before interest and taxes. Financial leverage is caused by fixed financial costs like interest and measures how changes in earnings before interest and taxes affect earnings per share. Combined leverage multiplies the effects of operating and financial leverage and represents the total risk faced by a firm.
Leverage - Financial, Operating and Combined
- 1. Leverage Operating, Financial and Combined JITHIN K THOMAS BIMS
- 2. Leverage • Leverage is an asset/source of finance for which firm pays fixed return/fixed cost .
- 3. Operating Leverage • Operating Leverage is caused due to fixed operating expenses in a firm. • Operating Leverage is the firms ability to use fixed operating costs to magnify the effects of changes in sales on its earnings before interest and taxes(EBIT).
- 4. Operating Leverage • Operating Risk – Risk of not able to cover fixed operating costs by firm.
- 5. Financial Leverage • Financial Leverage is caused due to fixed financial cost (interest)in a firm. • Financial Leverage is the firms ability to use fixed financial charges to magnify the effects of changes in EBIT on its earnings per share (EPS).
- 6. Financial Leverage • Financial Risk – Risk of not able to cover fixed financial costs by firm.
- 7. EBIT –EPS Analysis • EBIT –EPS Analysis involves comparison of alternative methods of financing at various levels of EBIT. • Financial Break Even Point is the level of EBIT which is equal to firms fixed financial costs.
- 8. Combined Leverage • Combined Leverage is the product of operating leverage and financial leverage • Total Risk is the associated with combined leverage.