Lets take a example to explain the relationship between financial leverage and operating leverage
Operating & cost data of XYZ Ltd are.
Sales Rs.20,00,000
Variable costs Rs.14,00,000
Fixed costs Rs.04,00,000 (including 15% interest on Rs. 10,00,000)
Calculate its operating, Financial & combined leverages.
Sales: Rs. 20,00,000
Variable costs : Rs 14,00,000
Fixed costs: Rs 04,00,000 (including 15% interests on Rs. 10,00,000)
Contribution = selling price – Variable costs
= 20,00,000 – 14,00,000
= 6,00,000
Fixed costs Before interest = 4,00,000 – 1,50,000
= 2,50,000
Profit = Contribution – fixed cost before interest (Before Interest)
= 6,00,000 – 2,50,000
= 3,50,000
Profit After Interest = contribution – fixed cost
= 6,00,000 – 4,00,000
= 2,00,000
Combined Leverage = operating Leverage × Financial Leverage
= 1.7142857 ×1.75
= 3.00
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