Leverage Analysis Complete Chapter No 6 | CA Inter Financial Management | As Per ICAI New Scheme
In This Video We Will Discuss Leverage Analysis all Concepts, Problems and Examples for CA Inter and CA Inter Financial Management (FM) Chapter 6 All Problems and Solutions has been discussed by Chandan Poddar Sir For CA Intermediate Grooming Education.
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Topic Covered:
Meaning and type of leverage
Concept of operating leverage
Relationship between breakeven point and operating leverage
Relationship between change in sales and change in EBIT using OL
Relationship between EBIT, OL and BEP
Summary of all points in operating leverage
Questions on operating leverage
Financial leverage
Relationship of financial leverage with EBIT, Interest and EPS
Combined leverage with a question for practice
Question for practice
The term ‘Leverage’ in general refers to a relationship between two interrelated variables. In financial analysis it represents the influence of one financial variable over some other related financial variable. Variables may be costs, output, sales, EBIT, EPS, etc.
Commonly used measures of leverage in Financial Analysis are:
1. Operating Leverage
2. Financial Leverage
3. Combined Leverage
Leverage provides the framework for financing decisions of a firm. It may be defined as the employment of an asset or source of funds for which the firm has to pay a fixed cost, or fixed return.
The best mixture of source of funds decides about the capital structure of the firm. The desired structure of the funds influences the shareholder’s return and risk.
Leverage analysis is the technique used by business firms to quantify a risk-return relationship of different alternative capital structure.
IMPACT OF LEVERAGE ON CAPITAL TURNOVER AND WORKING CAPITAL
An increase in sales improves net profit ratio, raising ROI to a higher level. Raise in Capital Turnover must be supported by adequate capital base. Normally, as Capital Turnover ratio increases, Working Capital ratio deteriorates.
When turnover/activity increases without corresponding rise in Working Capital, the Working Capital becomes tight.
OPERATING LEVERAGE
Refers to the extent to which the firm has fixed operating costs. A firm with high operating leverage will have relatively high fixed costs in comparison with a firm with low operating leverage.
FINANCIAL LEVERAGE
Finance Leverage is related to the financing activities of the firm. It results from the presence of fixed financial charge.Financial leverage is defined as the ability of a firm to use fixed financial changes to magnify the effect of changes in EBIT/Operating profits, on the firms EPS.
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