LEVERAGE

• Levers can be used to exert a large force at one

end by exerting only a small force at the other
end.
• Income = Revenue – Costs

• Costs : Fixed and Variable.

• Fixed Costs:
(i) Production related
(ii) Financing related.
• Two Types of Leverage
(i) Operating Leverage: Associated with
investment or asset acquisition
(ii) Financial Leverage: Associated with financing
activity.
Operating Leverage : Determines the relationship
between the firm’s sales revenue and EBIT.
Financial Leverage: Determines the relationship
between the EBIT and PAT.
 Operating Leverage
• It may be defined as the firm’s ability to use
fixed operating costs to magnify the effect of
changes in sales on its EBIT.
• It examines the effect of the change in the
quantity produced on the EBIT of the company.
Concept of Degree of Operating Leverage (DOL)
• Implications:
DOL answers: If output is increased by 10
percent, by what percentage the operating
income will change.
 Observations
1. For each level of output, there is a distinct
DOL.
2. DOL is undefined at Break Even Point.
3. If quantity produced is less than the
Operating BE quantity, the will be negative.
4. If quantity produced is more than the
Operating BE quantity, the will be positive.
5. The DOL will start to decline as the level of
output increases and will tend to 1.