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Operating Leverage - Capital Structure, Accountancy and Financial management Video Lecture | Accountancy and Financial Management - B Com
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FAQs on Operating Leverage - Capital Structure, Accountancy and Financial management Video Lecture - Accountancy and Financial Management - B Com
| 1. What is operating leverage and how does it relate to capital structure? |  |
Ans. Operating leverage refers to the degree to which a company's operating income is affected by changes in its sales revenue. It measures the sensitivity of a company's earnings to changes in sales volume. Operating leverage is directly related to a company's capital structure as it depends on the mix of fixed and variable costs. A higher proportion of fixed costs in the capital structure increases the operating leverage of a company, making its earnings more sensitive to changes in sales.
| 2. How is operating leverage calculated? | |
Ans. Operating leverage can be calculated using the following formula:
Operating Leverage = Contribution Margin / Operating Income
Contribution margin is the difference between sales revenue and variable costs, while operating income is the difference between sales revenue and both variable and fixed costs. By dividing the contribution margin by the operating income, we can determine the level of operating leverage.
| 3. What are the advantages of high operating leverage? | |
Ans. High operating leverage can provide several advantages to a company. Firstly, it can lead to higher profitability when sales increase, as the fixed costs remain the same while the contribution margin increases. Secondly, it can enhance the company's ability to generate higher returns on investment by leveraging fixed costs. Lastly, high operating leverage can provide a competitive advantage by allowing the company to offer competitive pricing due to its lower variable costs.
| 4. What are the risks associated with high operating leverage? | |
Ans. High operating leverage also has its risks. One major risk is the potential for losses when sales decline. Since fixed costs remain constant, a decrease in sales can lead to a significant reduction in operating income, potentially resulting in losses. Additionally, high operating leverage can make a company more vulnerable to economic downturns or changes in market conditions. It can limit the company's flexibility to adjust costs quickly and adapt to changing circumstances.
| 5. How can a company manage its operating leverage? | |
Ans. A company can manage its operating leverage by carefully analyzing its cost structure and making strategic decisions. One approach is to balance fixed and variable costs to reduce the overall level of operating leverage. By increasing variable costs and decreasing fixed costs, a company can decrease its sensitivity to changes in sales volume. Additionally, diversifying the product or service offerings can help mitigate the risks associated with high operating leverage. Regular monitoring of sales trends and market conditions can also aid in managing operating leverage effectively.
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Dec 23, 2024 Last updated |
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