The financial variables studied in each of the three major leverage effects

Three forms of financial leverage effect:

The financial leverage effect consists of the following three forms: three ways are: operating leverage, financial leverage and compound leverage.

Operating leverage

Meaning of operating leverage

Operating leverage is the leverage effect whereby the change in EBITDA is greater than the change in volume of production and sales due to the presence of fixed costs.

Measurement of operating leverage

The most commonly used measure of operating leverage is the operating leverage coefficient or degree of operating leverage. The operating leverage factor is the multiple of the rate of change in EBITDA equal to the rate of change in volume of production and sales.

Calculated as:

Operating leverage coefficient = change in EBITDA / change in volume of production and sales

Simplified formula for operating leverage coefficient is:

Operating leverage coefficient for the reporting period = marginal contribution for the base period / EBITDA for the base period

Relationship between operating leverage and operating risk

Operating leverage coefficient, Fixed costs and business risk are changing in the same direction, that is, in the case of other factors, the higher the fixed costs, the greater the operating leverage coefficient, the greater the risk of business operations. The relationship can be expressed as follows:

Operating leverage coefficient = base period marginal contribution / (marginal contribution - base period fixed costs)

Financial leverage

The concept of financial leverage

Financial leverage is the leverage effect that results in the change in the earnings per share of the ordinary share being greater than the change in EBITDA due to the presence of debt.

Measurement of financial leverage

The primary indicator for the measurement of financial leverage is the financial leverage factor. The coefficient of financial leverage is the multiple of the change in earnings per common share over the change in EBITDA.

The formula is:

Financial leverage coefficient = change in EPS/change in EBITDA

Financial leverage = base-period EBITDA/(base-period EBITDA - base-period interest)

For the enterprise that has both bank borrowings, finance leases, and the issuance of preferred shares, the financial leverage can be calculated according to the following formula Coefficient:

Financial leverage coefficient = EBITDA/[EBITDA - interest - finance lease accretion - (preferred share dividend/1 - income tax rate)]

Financial leverage and the relationship between financial risk

Financial risk refers to the enterprise in order to obtain the benefits of financial leverage to the use of debt funds, increase the chances of insolvency or substantial changes in the earnings per common share The risk associated with the opportunity. Financial leverage increases financial risk, and the greater the proportion of debt raised by the enterprise, the stronger the financial leverage effect and the greater the financial risk. The relationship between financial leverage and financial risk can be tested by calculating and analyzing the earnings per common share and its standard deviation and standard deviation ratio under different capital structures.

Compound Leverage

Concept of Compound Leverage

Compound Leverage is the leverage effect whereby the change in earnings per common share is greater than the change in the volume of production and sales operations due to the presence of fixed production and operating costs and fixed financial expenses.

Measurement of Compound Leverage

The primary indicator for the measurement of compound leverage is the compound leverage coefficient or compound leverage degree. The compound leverage factor is the multiple of the rate of change in earnings per common share equal to the rate of change in business volume.

The formula is:

Compound leverage coefficient = the rate of change in earnings per common share / the rate of change in business volume of production and sales

Or: compound leverage coefficient = operating leverage coefficient × financial leverage coefficient

Compound leverage and the relationship between business risk

The risk resulting from the compound leverage that makes the profit per common share fluctuate significantly, is called compound risk. is called compound risk. Compound risk directly reflects the overall risk of the business. In the case of other factors remain unchanged, compound leverage coefficient, the greater the compound risk; compound leverage coefficient is smaller, the smaller the compound risk. By calculating and analyzing the compound leverage coefficient and the standard deviation and standard deviation rate of earnings per common share can reveal the intrinsic connection between compound leverage and compound risk.