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Leverage Analysis: Vincent Joseph D. Disu, CPPS, Mba

The document discusses leverage analysis and its two main components - operating leverage and financial leverage. Operating leverage affects a firm's business risk based on its use of fixed versus variable operating costs, while financial leverage impacts a firm's financial risk through its use of debt versus equity. Breakeven analysis is also covered as a tool to illustrate the effects of operating leverage on a firm's profitability.

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Maria Maganda Maldita
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52 views17 pages

Leverage Analysis: Vincent Joseph D. Disu, CPPS, Mba

The document discusses leverage analysis and its two main components - operating leverage and financial leverage. Operating leverage affects a firm's business risk based on its use of fixed versus variable operating costs, while financial leverage impacts a firm's financial risk through its use of debt versus equity. Breakeven analysis is also covered as a tool to illustrate the effects of operating leverage on a firm's profitability.

Uploaded by

Maria Maganda Maldita
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Leverage Analysis

VINCENT JOSEPH D. DISU, CPPS, MBA

Leverage Analysis | Strategic Management


Leverage

 Operating Leverage:
 The use of fixed operating costs as opposed to variable
operating costs
 A firm with relatively high fixed operating costs will
experience more variable operating income if sales change

 Financial Leverage:
 The use of fixed-cost sources of financing (debt, preferred
stock) rather than variable-cost sources (common stock)

Leverage Analysis | Strategic Management


Leverage Analysis

 Operating Leverage
 Affects a firm’s business risk
 Business risk is the variability or uncertainty of a firm’s
operating income (EBIT)
 Financial Leverage
 Affects a firm’s financial risk
 Financial risk is the variability or uncertainty of a firm’s
earnings per share (EPS) and the increased probability of
insolvency that arises when a firm uses financial leverage

Leverage Analysis | Strategic Management


Breakeven Analysis

 Illustrates the effects of operating leverage


 Useful for forecasting the profitability of a firm, division
or product line
 Useful for analyzing the impact of changes in fixed
costs, variable costs, and sales price
 Terms:
 P: price per unit, Q: quantity produced, V: variable costs
per unit, VC; total variable costs, F; total fixed costs, TC:
total cost (VC+F), S: sales ($)

Leverage Analysis | Strategic Management


Breakeven Analysis Total Revenue
(PQ)
$

Leverage Analysis | Strategic Management


Quantity
Costs
 Suppose the firm has both fixed operating costs (administrative salaries,
insurance, rent, property tax) and variable operating costs (materials, labor,
energy, packaging, sales commissions)

Leverage Analysis | Strategic Management


Breakeven Analysis

Total Revenue

$ Total Cost

+
} (QV)+F or
VC+F
EBIT

FC {
-
Leverage Analysis | Strategic Management

Breakeven EBIT Q1 Quantity


Operating Leverage
 What happens if the firm increases its fixed operating costs and reduces (or
eliminates) its variable costs?

Leverage Analysis | Strategic Management


Breakeven Analysis
With high operating leverage, an increase
in sales produces a relatively larger Total Revenue
increase in operating income.

}
Trade-off: the firm has a higher breakeven
point. If sales are not high enough, the firm
will not meet its fixed expenses! EBIT
+

{
Total Cost
- = Fixed
FC

Leverage Analysis | Strategic Management


Q1 Quantity
Breakeven EBIT
Breakeven Calculations – Quantity
F
QB =
P-V
where
Q B : breakeven level of Q
F : total anticipate d fixed costs
P : sales price per unit
V : variable cost per unit
P - V is the Contributi on Margin
Leverage Analysis | Strategic Management
Breakeven Calculations – Sales
F
S* =
VC
1-
S
where
S* : breakeven level of sales
F : total fixed costs
S : total sales
VC : total variable costs
VC
Note that is assumed to be constant
S
Leverage Analysis | Strategic Management
Analytical Income Statement

sales
- variable costs
- fixed costs
} contribution margin
operating income (EBIT)
- interest
EBT
- taxes
net income
EBT (1 – t) = Net Income,
so,
Net Income / (1 – t) = EBT
Leverage Analysis | Strategic Management
Example
 Based on the following information on a Levered Company, answer these
questions:

1) If sales increase by 10%, what should happen to operating income?


2) If sales increase by 10%, what should be the effect on EPS?

Leverage Analysis | Strategic Management


Levered Company – Data
Sales (100,000 units) $1,400,000
Variable Costs $800,000
Fixed Costs $250,000
Interest paid $125,000
Tax rate 34%
Shares outstanding 100,000

Leverage Analysis | Strategic Management


Levered Company – Base Level Data
Sales (100,000 units) $1,400,000
Variable Costs ($800,000)
Fixed Costs ($250,000)
EBIT (Operating Income) $350,000)
Interest paid ($125,000)
EBT $225,000
Tax @ 34% ($75,500)
EAT (Net Income) $148,500
EPS = $148,500 / 100,000 = $1.485
Leverage Analysis | Strategic Management
Levered Company
10% increase in sales
Sales (110,000 units) 1,540,000
Variable Costs (880,000)
Fixed Costs (250,000)
EBIT 410,000 ( +17.14%)
Interest (125,000)
EBT 285,000
Taxes (34%) (96,900)
Net Income 188,100
EPS $1.881 ( +26.67%)
Leverage Analysis | Strategic Management
References:

 Accounting Course Online, Academia 2018


 STRAMA Paper on Axxis Resources Corp. 2019

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