Financial Mngmt

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Querist : Anonymous

Querist : Anonymous (Querist)

15 January 2011 hi experts,
what is operating and financial leverage?why a comapny should have high operating leverage and low financial leverage?pls expalain with a xample

CA SURENDRA KUMAR RAKHECHA

CA SURENDRA KUMAR RAKHECHA (Expert)
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15 January 2011 Operating leverage is a

measure of how sensitive

net operating income

is to percentage changes

in sales.

Operating leverage acts as a multiplier.

If operating leverage is high, a small percentage increase in sales can produce a much larger percentage increase in net operating income.

.............................

In simple terms;

where a 10% increase in sales gives

profits more than 20% before;

it is said it is High Operating Leverage.

CA SURENDRA KUMAR RAKHECHA

CA SURENDRA KUMAR RAKHECHA (Expert)
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15 January 2011 It means increase in sales is desirable.

.

Hence action plan would be to focus on Marketing of the product to increase sale.

And

if Production is not to that extnet; then also try to increase the production.

( Management Percespective )

CA SURENDRA KUMAR RAKHECHA

CA SURENDRA KUMAR RAKHECHA (Expert)
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15 January 2011
In finance,

leverage

is a technique

to multiply gains and losses.

Common ways to attain leverage are borrowing money, buying fixed assets and using derivatives.

.....................................

In simple term; we see so many persons take loan for the business.

Why ?

(Example) :

Because they see a margin of 10% of sales of Rs. 5,00,000 ( suppose they invest Rs. 10,00,000 to achieve this sale).

In real term they earn 5% every month of their investment.

OK ?

It means if they have more sales in their hands ( demand )but losing it due to lack of capital, they will borrow to have advantage of the opportunity.

If the said loan is available @ 12% p.a. then the cost which they bear is 1% per month towards this.

Hence by introducing more money they earn 4% additional surplus on bringing loans in the business.

CA SURENDRA KUMAR RAKHECHA

CA SURENDRA KUMAR RAKHECHA (Expert)
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15 January 2011 ( Humour )

I have used the maximum space of caclub to expand my answer.

It is also one type of leverage.

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