Degree of Operating Leverage

Operating supplementOperating leverage is the term that describes the jounce on in opeproportionn(p)(a) income of a change in the take of output. Brigham says that If a spunky percentage of a firms costs are fixed, and hence do non decline when demand decreases, this increases he phoners business stake. This factor is called operating leverage. If a high percentage of a firms total costs are fixed, the firm is utter to have a high degree of operating leverage. The degree of operating leverage (DOL) is defined as the percentage change in operating income (or EBIT) that results from a accustomed percentage change in gross sales.In resultant role, the DOL is an index number which measures the violence of a change in sales number of units on operating income, or EBIT.AutronGenerally, the higher(prenominal) the operating leverage, the more than a conjunctions income is involveed by fluctuation in sales pot. The higher income vs. sales ratio results from a smaller portio n of variable costs, which means the Company does not have to pay as much additional money for each unit produced or sold. The more signifi lott the volume of sales, the more beneficial the investment in fixed costs becomes. Applying this principle the operating leverage of Autron is in a good position and any change in sales volume will not violently actuate the income of this company.AmbertechThe position of this company with respect to the Operating Leverage is not advantageous to the company as the ratio is high. It signifies that the fixed costs are at a higher level. This means that any small change in sales volume will adversely affect the meshingability of the company.Degree of Financial LeverageCompanyDegree of Financial LeverageFinancial LeverageFinancial leverage is the term used to describe the impact on returns of a change to the extent to which the firms assets are financed with borrowed money. In their 1997 article Buccino and Mckinley define operating leverage as t he impact of a change in revenue on profit or cash flow. It arises, they say, whenever a firm can increase its revenues without a proportionate increase in operating expenses. Cash allocated to increasing revenue, such as marketing and business development expenditures, are promptly consumed by high fixed expenses.AutronThe degree to which a business is utilizing borrowed money. Companies that are highly leveraged may be at risk of bankruptcy if they are unable to make payments on their debt they may also be unable to find new lenders in the future. Financial leverage is not always bad, however it can increase the shareholders return on their investment and often there are tax advantages associated with borrowing. Applying this basic principle, with a low financial leverage, this company is utlising very lower level of borrowed funds. The interest burden on the company will naturally be less and the company is financing its operations from its own sources.AmbertechAs against the co mpany Autron, this company has high financial leverage which implies that the borrowings are more for this company and the company is running the risk of higher interest payments and meeting their debt commitments on dates.Combined LeverageA leverage ratio that summarizes the combined effect the degree of operating leverage (DOL), and the degree of financial leverage has on earnings per share (EPS), given a particular change in sales. This ratio can be used to help cook the most optimal level of financial and operating leverage to use in any firm. This ratio can be very useful, as it summarizes the effects of combining both financial and operating leverage, and what effect this combination, or variations of this combination, has on the corporations earningsAutronIt should be noted that a firm with a relatively high level of combined leverage is seen asriskier than a firm with less combined leverage, as thehigh leverage means more fixed costs to the firm. On the basis of the combine d leverage ratio, it can be stated that the company Auton is less riskier as the leverage ratio of 4.296 is highly advantageous to the firm signifying a lower level of fixed costs and better profitability. As we have seen in the Operating Leverage for this Company, any change in sales volume will result in more profits.AmbertechIn contrast to the company Autron, this company has a higher operating and financial leverage which has resulted in a higher combined leverage. This situation implies that the companys fixed costs are very high leading to lower profitability. Any change in sales volume will adversely affect the earnings of the company.References1. Brigham, Eugene F., Fundamentals of Financial Management (1995).2. Buccino, Gerald P. and Kraig S. McKinley, The Importance of Operating Leverage in a Turnaround, Secured lender (Sept./Oct. 1997), p. 64-68.