OPERATING & FINANCIAL

LEVERAGE
SUBMITTED BY NIKHIL BHARDWAJ
ROLL NO. 4834
INTRODUCTION OF OPREATING &
FINANCIAL LEVERAGE
Financial and Operating LeverageLeverage is common term in financial management which
entails the ability to amplify results at a comparatively low cost. In business, company's
managers make decisions about leverage that affect profitability. According to James Horne,
leverage is, "the employment of an asset or fund for which the firm pays a fixed cost or fixed
return". When they evaluate whether they can increase production profitably, they address
operating leverage. If they are expecting taking on additional debt, they have entered the
field of financial leverage. Operating leverage and financial leverage both heighten the
changes that occur to earnings due to fixed costs in a company's capital structures.
Fundamentally, leverage refers to debt or to the borrowing of funds to finance the purchase of
a company's assets. Business proprietors can use either debt or equity to finance or buy the
company's assets. Use of debt, or leverage, increases the company's risk of bankruptcy. It also
upsurges the company's returns, specifically its return on equity. It is a fact because, if debt
financing is used rather than equity financing, then the owner's equity is not diluted by issuing
more shares of stock. Investors in a business like for the business to use debt financing but
only up to a point. Investors get nervous about too much debt financing as it drives up the
company's default risk.
EXPLAIN THROUGH FIGURE :)
DIFFERENCE BETWEEN OPRATING &
FINANCIAL LEVERAGE
MEASUREMENT OF LEVERAGE
DEGREE OF FINANCIAL LEVERAGE
EFFECTS OF LEVERAGE ON NET INCOME
& RETURN ON EQUITY
A high degree of financial leverage implies that a company has high levels of interest
payments which could negatively impact the company’s net income, its bottom-line
earnings per share as well as its return on equity (ROE). However, financial leverage
really increases the variability of a company’s net income and its return on equity,
which means that the two can either increase or decrease depending on the impact
of other factors such as the macroeconomic environment.An increase in a company’s
use of debt financing increases the company’s risk of default, but it also increases
the likelihood that the company’s operating earnings, net income, and ROE will
increase in good economic times. Ultimately, financial leverage increases the risk of
ownership for a company’s shareholders but it also has the potential to magnify the
return they receive from their ownership.At what would be considered optimal
financial leverage, both a company’s net income and its ROE will increase. However,
if a company is financially over-leveraged then a decrease in both net income and
return on equity could occur.
INTEREST IMPACT AND GROWTH
DEVELOPMENT
 Interest ImpactOne of the most direct ways leverage negatively affects
ongoing profit is payment of interest. When you owe money, you pay the
lender interest over time. Every dollar in interest reduces your profit by the
same amount. If you get a low interest rate on a particular loan, the cost of
the interest may make a reasonable investment. Trade buyers often purchase
inventory on account and pay interest to carry the debt. The inventory
flexibility is a positive tradeoff.Growth and DevelopmentTo launch or grow a
business, you have two basic ways to finance the move. You can seek out
investment money or get a loan. If you prefer to maintain greater control
with debt financing, you accept the repayment obligations as part of the
deal. In the long run, a business may generate greater profit through business
expansion. Plus, each owner gets a greater share of the profit in that scenario
if you borrowed money instead of inviting more owner-investors.
Thank you