Leverage

3.  Christy and Roden define leverage as the tendency for profits to
change at a faster rate than sales. It is a relationship between
equity share capital and securities and creates fixed interest and
dividend charges. It is also known as “gearing. "The term gearing
explains the relationship between the equity capital and fixed
bearing securities.
 According to James Horne “Leverage is the employment of an
asset or funds for which the firm pays a fixed cost or fixed
return”.
 It is a tool of financial planning. Leverage helps the management
in controlling the fixed cost relating to sales.Thus,leverage is a
cost depicting tool.

8.  Financial Leverage = Operating Income(EBIT)
Taxable Income(EBT)
OR
Financial Leverage =EBIT
EBIT –I(I=Interest)
Financial leverage signifies the relationship
between the earning power on equity capital
and rate of interest on borrowed capital.

11.  If the earnings of the company has more amount of fixed cost of
interest(which would arise due to more debt capital),the overall
returns of company get reduced and financial risk increases. This
may be an unfavourable situation for the business concern. The
more accepted ratio between debt to equity is 2:1.This ratio
favours leverage effect on equity shares and would get higher
percentage of earnings.
 Financial leverage used to analyze financial risk

12.  There are two major classification of costs in the organisation .
They are : ( a ) Fixed cost , ( b ) Variable cost . The operating
leverage has a bearing on fixed costs . There is a tendency of the
profits to change , if the firm employs more of fixed costs in its
production process, greater will be the operating cost irrespective
of the size of the production . The operating leverage will be at a
low degree when fixed costs are less in the production process .
Operating leverage shows the ability of a firm to use fixed
operating cost to increase the effect of change in sales on its
operating profits . It shows the relationship between the changes in
sales and the charges in fixed operating income . Thus , the
operating leverage has impact mainly on fixed cost , variable cost
and contribution . It indicates the effect of a change in sales
revenue on the operating profit ( EBIT ) , Higher the operating
leverage indicates higher the amount of fixed cost and reduces the
operating profit and increases the business risks .

16.  Higher the operating leverage indicates
higher the amount of fixed cost and reduces
operating profit and increases the business
risk

18.  This leverage shows the relationship between a change in sales
and the corresponding variation in taxable income . If the
management feels that a certain percentage change in sales would
result in percentage change to taxable income they would like to
know the level or degree of change and hence they adopt this
leverage . Thus , degree of leverage is adopted to forecast the
future study of sales levels and resultant increase / decrease in
taxable income . This degree establishes the relationship between
contribution and taxable income .