The relationship between the firms EBIT and earnings available for shareholders is known asa)Operating leverageb)Financial leveragec)Combined leveraged)Accounting rate of returnCorrect answer is option 'B'. Can you explain this answer?

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The relationship between the firms EBIT and earnings available for shareholders is known as

a)
Operating leverage
b)
Financial leverage
c)
Combined leverage
d)
Accounting rate of return

Correct answer is option 'B'. Can you explain this answer?

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The relationship between the firms EBIT and earnings available for sha...

Leverage:

Leverage is the process of using debt (borrowed money) to increase the profits of an investment or enterprise.
Leverage allows investors to increase their purchasing power in the market.
Leverage is the financing of assets by businesses; rather than selling shares to obtain capital, businesses can use debt to invest in their operations in an effort to boost shareholder value.

Important Points

Financial leverage

It is relationship between the firms EBIT and earnings available for shareholders.
The proportion of debt in the overall capital is also called financial leverage.
Financial leverage is computed as D/E or D/(D + E) where D is the Debt and E is the Equity.
As the financial leverage increases, the cost of funds declines because of increased use of cheaper debt but the financial risk increases.

Operating leverage

It measures the effect of change in Sales Quantity and operating capacity on EBIT.
It is a cost-accounting formula that measures the degree to which a firm or project can increase operating income by increasing revenue.
A company that generates sales with a high gross margin and low variable costs has high operating leverage.
It is useful in ascertaining the effect of a change in sales quantity on operating profit.

Combined leverage

It refers to high profits due to fixed costs.
A degree of combined leverage (DCL) is a leverage ratio that summarizes the combined effect that the degree of operating leverage (DOL) and the degree of financial leverage has on earnings per share (EPS), given a particular change in sales.

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The relationship between the firms EBIT and earnings available for sha...

Leverage:

Leverage is the process of using debt (borrowed money) to increase the profits of an investment or enterprise.
Leverage allows investors to increase their purchasing power in the market.
Leverage is the financing of assets by businesses; rather than selling shares to obtain capital, businesses can use debt to invest in their operations in an effort to boost shareholder value.

Important Points

Financial leverage

It is relationship between the firms EBIT and earnings available for shareholders.
The proportion of debt in the overall capital is also called financial leverage.
Financial leverage is computed as D/E or D/(D + E) where D is the Debt and E is the Equity.
As the financial leverage increases, the cost of funds declines because of increased use of cheaper debt but the financial risk increases.

Operating leverage

It measures the effect of change in Sales Quantity and operating capacity on EBIT.
It is a cost-accounting formula that measures the degree to which a firm or project can increase operating income by increasing revenue.
A company that generates sales with a high gross margin and low variable costs has high operating leverage.
It is useful in ascertaining the effect of a change in sales quantity on operating profit.

Combined leverage

It refers to high profits due to fixed costs.
A degree of combined leverage (DCL) is a leverage ratio that summarizes the combined effect that the degree of operating leverage (DOL) and the degree of financial leverage has on earnings per share (EPS), given a particular change in sales.

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The relationship between the firms EBIT and earnings available for shareholders is known asa)Operating leverageb)Financial leveragec)Combined leveraged)Accounting rate of returnCorrect answer is option 'B'. Can you explain this answer?

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