2 if any change in the sales it will lead to

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2. If any change in the sales, it will lead to corresponding changes in profit. 3. Operating leverage helps to identify the position of fixed cost and variable cost. 4. Operating leverage measures the relationship between the sales and revenue of the company during a particular period. 5. Operating leverage helps to understand the level of fixed cost which is invested in the operating expenses of business activities. 6. Operating leverage describes the over all position of the fixed operating cost. FINANCIAL LEVERAGE Leverage activities with financing activities is called financial leverage. Financial leverage represents the relationship between the company’s earnings before interest and taxes (EBIT) or operating profit and the earning available to equity shareholders. Financial leverage is defined as “the ability of a firm to use fixed financial charges to magnify the effects of changes in EBIT on the earnings per share”. It involves the use of funds obtained at a fixed cost in the hope of increasing the return to the shareholders. “The use of long-term fixed interest bearing debt and preference share capital along with share capital is called financial leverage or trading on equity”. Financial leverage may be favourable or unfavourable depends upon the use of fixed cost funds. Favourable financial leverage occurs when the company earns more on the assets purchased with the funds, then the fixed cost of their use. Hence, it is also called as positive financial leverage.
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Unfavourable financial leverage occurs when the company does not earn as much as the funds cost. Hence, it is also called as negative financial leverage. Financial leverage can be calculated with the help of the following formula: Where, FL = Financial leverage OP = Operating profit (EBIT) PBT = Profit before tax. Degree of Financial Leverage Degree of financial leverage may be defined as the percentage change in taxable profit as a result of percentage change in earning before interest and tax (EBIT). This can be calculated by the following formula DFL= Percentage change in taxable Income Percentage change in sales Uses of Financial Leverage Financial leverage helps to examine the relationship between EBIT and EPS. Financial leverage locates the correct profitable financial decision regarding capital structure of the company. Financial leverage is one of the important devices which is used to measure the fixed cost proportion with the total capital of the company. If the firm acquires fixed cost funds at a higher cost, then the earnings from those assets, the earning per share and return on equity capital will decrease. DISTINGUISH BETWEEN OPERATING LEVERAGE AND FINANCIAL LEVERAGE Operating Leverage Financial Leverage Operating leverage is associated with investment activities of the company.
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