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CA Intermediate · Financial Management and Strategic Management · Financing Decisions - Leverages

Which of the following correctly defines Operating Leverage (OL) as used in the ICAI Financial Management study material?

Operating leverage is measured as contribution divided by EBIT. It shows how a given percentage change in sales is magnified into a larger percentage change in EBIT because of fixed operating costs. The other ratios describe financial or combined leverage.

  1. APercentage change in EPS divided by percentage change in EBIT
  2. BContribution divided by EBITCorrect
  3. CEBIT divided by EBT
  4. DPercentage change in EPS divided by percentage change in sales

Explanation

Degree of operating leverage is measured as Contribution / EBIT, showing how sensitive EBIT is to a change in sales. EBIT/EBT is the degree of financial leverage. The ratio of percentage change in EPS to percentage change in EBIT is also financial leverage, and EPS to sales change is combined leverage.

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