Premium Essay

Operating Leverage

In: Business and Management

Submitted By bossrick
Words 550
Pages 3
Bureaucratic Control

People do not like change. In fact, even when change leads to job improvement, such as making one’s job easier or more efficient, people will initially resist it. In the company overview, Jack and Jenny can outline what the employee can expect of the company and what the company in turn expects from them. If employers evolve as their workers evolve, the end result will be a more dynamic and competitive organization where knowledge is shared, action is taken quickly and new possibilities are opened. The performance of an employee cannot be measured effectively unless a standard has been set against which to measure the employee's daily performance. When you are setting performance standards, it is helpful to clearly state, “Here is what meeting expectations looks like and here is what exceeding expectations would look like.” Clear expectations provide a solid foundation on which to provide recognition and reinforcement as well as guidance and corrective feedback. It's not fair to hit people with corrective feedback or a bad review if you have not made your expectations clear. An employee handbook can help managers and workers know how to deal with difficult situations.
Employee performance can be improved just as much if not more by general management practices that recognize the individual. The best way managers can measure performance is to be as open as possible about how they make decisions, and to have a clear rationale for decisions and policies. It's also important to be consistent about how decisions are made and to respond to questions in a sensitive, respectful way. This has a number of advantages. Problems can be caught earlier on, feedback can be much more specific, and employees are more likely to learn from feedback if they receive it soon after an event and in the context of…...

Similar Documents

Premium Essay

Operating Leverage

...changed. OPERATING LEVERAGE: Operating leverage can be risky. When does an organization benefit from having a high degree of operating leverage? When does it lose from having a high degree of operating leverage? First, operating leverage arises from fixed costs in organizations structure. As the proportion of fixed costs to contribution margin rise, the operating leverage rises. Some industries may be forced to have a high degree of operating leverage because the nature of their business requires high fixed costs. These include; airlines, newspapers, pharmaceuticals, and utilities. Some industries can make choices about their leverage, either by outsourcing fixed cost components (paying another company to provide the service/equipment) or by choosing between labor (variable cost wages) or machines (fixed costs). The Healthcare industry is not considered a high leverage industry yet, but I am sure that the leverage is increasing with more advanced equipment. Sales do not affect the degree of leverage, but the nature of the sales may determine how much leverage should be used. If sales are relatively stable, the organization can utilize a higher degree of leverage. If sales fluctuate or are otherwise unstable, the organization should try to maintain a lower degree of leverage. How? A simply way is too use variable hourly labor instead of automated fixed equipment. Be careful that you don’t get confused by variable costs. Variable costs, as it pertains to operating leverage,......

Words: 837 - Pages: 4

Premium Essay

Operating Leverage

...Discussion Week 3: Read Exercise 4-1 (Note: This is will not be done as a group assignment). Answer end of exercise question and post answer in discussion board. Operating Leverage: John Diaz owns Pacific Electric, a large electrical contracting firm that provides services to building construction projects. The company has 2,000 employees and operates in three western states. Recently the company experienced large losses due to a downturn in the economy and a slowdown in construction. John thinks the losses were particularly large because his company has too much fixed cost. Required: a. Expand on John’s thought. How are the large losses related to fixed costs? In management accounting, fixed costs are defined as expenses that do not change as a function of the activity of a business, within the relevant period. For example, a retailer must pay rent and utility bills irrespective of sales. In John’s case, I will assume that he will have a Cost-Volume-Profit Analysis performed. I would hope also that this analysis would be performed on each of his businesses in the three states that he operates within and at a corporate level. No company should go on gut feelings when it comes to saving their business and this could be the situation for John. Cost-Volume-profit (CVP), in managerial economics is a form of cost accounting. It is a simplified model, useful for elementary instruction and for short-run decisions. Cost-volume-profit (CVP) analysis expands the use of......

Words: 772 - Pages: 4

Premium Essay

Relationship Between Accounting Data, Operating and Financial Leverage and Investment Risk

...room remains for additional research (Ryan, 1997). The theoretical work began with Hamada (1972) and Rubinstein (1973) who identified the multiplicative impact of financial leverage on the beta of the levered firm. Their, by now, well known results is that: [pic] where ( = the levered firm’s common stock beta, (* = the unlevered firm’s common stock beta, ( = the corporate income tax rate, D = the market value of debt, and E = the market value of common equity. Whilst (* was called operating risk, Rubinstein recognised that it reflected the combined effects of operating leverage, the pure systematic influence of economy wide events and uncertainty surrounding the firm’s operating efficiency. Lev (1974) separated operating leverage from the other two variables and found it to be individually significant. Mandelker and Rhee (1984) explicitly incorporate measures of the degree of operating and financial risk into their theoretical model and arrive at the following relationship: [pic] where: (j = the levered firm’s common stock beta, DOL = the degree of operating leverage = [pic] where: Xjt = earnings before interest and taxes for company j in period t, and Sjt = sales for company j in period t, and ( represents expectations DFL = the degree of financial leverage = [pic] where: (jt = earnings after interest and taxes for company j in period t, and [pic] = the intrinsic business risk of common equity of company j =......

Words: 3189 - Pages: 13

Premium Essay

Leverage Notes

...LEVERAGE ANALYSIS Leverage arises from the presence of fixed costs in a firm’s cost structure. Two types of leveragea) Operating Leverage and b) Financial Leverage. •Operating leverage arises from fixed operating costs (depreciation, salaries, advertisement etc). •Financial leverage from the presence of fixed financing costs such as interest. Concepts that enhance our understanding of risk... 1) Operating Leverage - affects a firm’s business risk. 2) Financial Leverage - affects a firm’s financial risk. Operating Leverage The use of fixed operating costs as opposed to variable operating costs. A firm with relatively high fixed operating costs will experience more variable operating income if sales change. So it is the responsiveness of the firm’s EBIT to fluctuations in sales. Costs • Suppose the firm has both fixed operating costs (administrative salaries, insurance, rent, property tax) and variable operating costs (materials, labor, energy, packaging, sales commissions). Total Revenue Rs }EBIT Total Cost + Breakeven point Q1 Quantity { - FC Operating Leverage • What happens if the firm increases its fixed operating costs and reduces (or eliminates) its variable costs? Total Revenue Rs + FC } Q1 EBIT Total Cost = Fixed { New Breakeven Point with FC Old Breakeven Point with VC &FC Quantity With high operating leverage, an increase in sales produces a relatively larger increase......

Words: 829 - Pages: 4

Premium Essay

Financial Statement Analysis Term Papet

...Financial Statement Analysis of Leverage and How It Informs About Profitability and Price-to-Book Ratios DORON NISSIM dn75@columbia.edu Graduate School of Business, Columbia University, 3022 Broadway, Uris Hall 604, New York, NY 10027 STEPHEN H. PENMAN shp38@columbia.edu Graduate School of Business, Columbia University, 3022 Broadway, Uris Hall 612, New York, NY 10027 Abstract. This paper presents a financial statement analysis that distinguishes leverage that arises in financing activities from leverage that arises in operations. The analysis yields two leveraging equations, one for borrowing to finance operations and one for borrowing in the course of operations. These leveraging equations describe how the two types of leverage affect book rates of return on equity. An empirical analysis shows that the financial statement analysis explains cross-sectional differences in current and future rates of return as well as price-to-book ratios, which are based on expected rates of return on equity. The paper therefore concludes that balance sheet line items for operating liabilities are priced differently than those dealing with financing liabilities. Accordingly, financial statement analysis that distinguishes the two types of liabilities informs on future profitability and aids in the evaluation of appropriate price-to-book ratios. Keywords: financing leverage, operating liability leverage, rate of return on equity, price-to-book ratio JEL Classification: M41, G32 Leverage is......

Words: 13315 - Pages: 54

Free Essay

Telecommunications

...Operating Leverage What Does Operating Leverage Mean? A measurement of the degree to which a firm or project incurs a combination of fixed and variable costs. (1) A business thathas limited sales, with each sale providing a very high gross margin, is said to be highly leveraged. A business that makesmany sales, with each sale contributing a very low margin, is said to be less leveraged. As the volume of sales in a businessincreases, each new sale contributes less to fixed costs and more to profitability. (2) A business that has a higher proportion offixed costs and a lower proportion of variable costs is said to use more operating leverage. Conversely, businesses with lowerfixed costs and higher variable costs are said to employ less operating leverage. Investopedia explains Operating Leverage The higher the degree of operating leverage, the greater the potential danger for inaccurately forecasting risk. That is, if arelatively small error is made in forecasting sales, it can be magnified into large errors in projections of cash flow. The oppositeis true for businesses that are less leveraged. A business that sells millions of products a year, with each contributing slightlyto paying for fixed costs, is not as dependent on each individual sale. For example, convenience stores are significantly lessleveraged than are high-end car dealershipsoperating......

Words: 634 - Pages: 3

Premium Essay

Leverage

...Table of contents Contents i. Introduction to Leverage 3 ii. Significance of the Issue 3 iii. What is Leverage? 4 iv. Kinds of Leverage 4 a) Financial Leverage. 4 b) Operating Leverage. 4 c) Combined Leverage 5 v. Risks of Leverage 5 vi. Conclusion 5 vii. List of references 6   i. Introduction to Leverage In finance, Leverage is considered to be any financial instrument or loaned capital used to increase the potential return of an investment. Leverage is usually used in real estate and often in the automobile industry in the form of mortgage to purchase houses or vehicles. Leverage aids both the shareholder and the firm, but it comes with great deal of risk. If an investor makes use of leverage to create an investment and it doesn’t go in his or her favor, their loss is much larger than it would've been if they hadn’t used leverage. Leverage amplifies both gains and losses. In the business world, a firm is able to make use of leverage to try to produce shareholder wealth, but if it is unsuccessful to do so, the interest expense and credit risk of damaging the shareholder's value. Leverage can be used in many branches of finance including bonds, stocks, currencies, commodities and also other investments. Leverage can either be a good or bad thing for the firm depending on the situations that arise. ii. Significance of the Issue Leverage is one of the main topics in finance, one cannot study finance without coming across words like investments, loans,......

Words: 929 - Pages: 4

Premium Essay

Finance

... Meaning of leverage  In general ,leverage refers to accomplish certain things which are otherwise not possible i.e. lifting of heavy objects with the help of lever. This concept of leverage is valid in business also .  In finance ,the term ‘leverage’ is used to describe the firm’s ability to use fixed cost assets or funds to increase the return to its owners; i.e. equity shareholders. In other words, the fixed cost funds i.e. debentures & preference share capital act as the fulcrum , which assist the lever i.e. the firm to lift i.e. to increase the earnings of its owner i.e. the equity shareholders.  If earnings less the variable costs exceed the fixed costs i.e. preference dividend & interest on debenture, or earnings before interest and taxes exceed the fixed return requirement, the leverage is called favorable . when they do not ,the result is unfavorable leverage .  Leverage is also the influence which an independent variable has over a dependent/related variable i.e. rainfall over production. In financial context, sales & fixed cost over profit. DIAGRAM Leverage in physics Leverage in finance LEVER LIFTING Increasing the earnings Fixed cost fund FULCRUM TYPES OF LEVERAGE OPERATING LEVERAGE The leverage associated with investment (asset acquisition) activities is referred as operating Leverage. Formula : operating leverage=contribution/operating profit Where , contribution=sales-variable cost operating......

Words: 1214 - Pages: 5

Premium Essay

Selection of Right Borrower

...MEANING OF OPERATING AND FINANCIAL LEVERAGE Operating leverage occurs any time a firm has fixed cost that must be met regardless of volume. operating leverage is the technique of magnifying the EBIT by using fixed costs that must be met regardless of volume in the capital structure. An entrepreneur generally employ assets with a fixed cost in the hope that volume will produce revenues more than sufficient to cover all fixed and variable costs. For example in an airline industry, a large portion of total cost are fixed. Beyond the break-even point each additional passenger represents essentially straight profit to the airline. So is the case of a bus or railway and so on. With fixed costs, the percentage change in profit accompanying a change in volume is greater than the percentage change in volume. This occurace is known as operating leverage. Operating leverage can be explained better by means of break-even or cost-volume-profit analysis. Financial Leverage may be defined as the use of fixed financial charges in the firm’s capital structure to magnify the Earning Per Share. Financial leverage occurs when funds with charges, such as debt and preference share are used with the owner’s equity in the capital structure. The financial leverage is employed by a company with an intention to earn more on fixed charges funds than their costs. It amy be compared to a fulcrum used in physics in the sense that the surplus over interest cost will be used as a lever or fulcrum to...

Words: 1043 - Pages: 5

Premium Essay

Financial Management

...SML401: Financial Management Term Paper Reliance Industries: A study Of Various Leverage Ratios and Dividend Policy Submitted by:- Abhishek Soni Sameer Pandit Lavesh Bhandari Chakradhar Reddy Table of Contents 1. Introduction 3 2. Objective 4 3. Analysis of Leverage ratios 5 4. Analysis of Dividend Policy and Valuation of shares 7 5. References 13 Reliance: A study INTRODUCTION The Reliance Group, founded by Dhirubhai H. Ambani (1932-2002), is India's largest private sector enterprise, with businesses in the energy and materials value chain. Group's annual revenues are in excess of US$ 34 billion. The flagship company, Reliance Industries Limited, is a Fortune Global 500 company and is the largest private sector company in India. The Group's activities span exploration and production of oil and gas, petroleum refining and marketing, petrochemicals (polyester, fibre intermediates, plastics and chemicals), textiles, retail and spacial economic zones. Reliance enjoys global leadership in its businesses, being the largest polyester yarn and fibre producer in the world and among the top five to ten producers in the world in major petrochemical products. The Group exports products in excess of US$ 20 billion to 108 countries in the world. Major Group Companies are Reliance Industries Limited (including main subsidiaries Reliance Petroleum Limited and Reliance Retail limited) and Reliance Industrial......

Words: 998 - Pages: 4

Premium Essay

Nike

...Chapter 13 Summary Leverage and Capital Structure Leverage refers to the effects that fixed costs have on the returns that shareholders earn. “Fixed costs” refer to costs that do not rise and fall with changes in a firm’s sales. Capital structure is the mix of long-term debt and equity maintained by the firm. Breakeven analysis is used to indicate the level of operations necessary to cover all costs and to evaluate the profitability associated with various levels of sales; also called cost-volume-profit analysis. Operating breakeven point is the level of sales necessary to cover all operating costs; the point at which EBIT = $0. Algebraic Approach: EBIT = (P x Q) – FC (VC x Q) Operating leverage is the use of fixed operating costs to magnify the effects of changes in sales on the firm’s earnings before interest and taxes. The degree of operating leverage (DOL) is a numerical measure of the firm’s operating leverage. It is: DOL = % change in EBIT/% change in sales. Financial leverage is the use of fixed financial costs to magnify the effects of changes in earnings before interest and taxes on the firm’s earnings per share. The degree of financial leverage (DFL) is a numerical measure of the firm’s financial leverage. DFL: % change in EPS/% change in EBIT Total leverage is the use of fixed costs, both operating and financial, to magnify the effects of changes in sales on the firm’s earnings per share. The degree of total leverage (DTL) is the......

Words: 433 - Pages: 2

Premium Essay

Leverage and Firm Risk

...basic industry and operating decisions of the firm. Business risk depends on a number of factors including the variability of demand for the firm’s products, the stability of sales prices and basic product input prices, and the extent to which the firm’s costs are fixed. Each of these factors is determined to some extent by the character of the firm's industry, but each of them is also controllable to some degree through the firm's strategic operating decisions. The second source of risk is financial risk. This risk is related to the firm’s financial policies, specifically the use of debt in financing operations. The use of debt obligates a firm to make interest and principal payments, regardless of profit levels. These fixed financial expenses compound fluctuations in operating income (EBIT) and introduce additional risk to stockholders. Separating business and financial risk convenient illustrates the division between firm operating and financial policies. Both are important and poor management in one area can easily undo good management in the other. Operating Leverage Business risk depends in part on the extent to which a firm builds fixed costs into its operations. If fixed costs are high, even a small change in sales can result in a large change in EBIT. The measure of a firm's operating risk is called operating leverage. If a high percentage of a firm's operating costs is fixed, the firm will have a high degree of operating leverage. As a......

Words: 4423 - Pages: 18

Premium Essay

Finance 3000

...creditor is most concerned about a firm's profitability ratios.  FALSE   5. Ratios are only useful for those areas of business that involve investment decisions.  FALSE 6. Debt utilization ratios are used to evaluate the firm's debt position with regard to its asset base and earning power.  TRUE 7. The DuPont system of analysis emphasizes that profit generated by assets can be derived by various combinations of profit margins and asset turnover.  TRUE   8. During disinflation, stock prices tend to go up because the investor's required rate of return goes down.  TRUE   9. Analysts agree that extraordinary gains/losses should be excluded from ratio analysis because they are one time events, and do not measure annual operating performance.  TRUE   10. Intangible assets are becoming an important part of the assets in a company's financial statements because accountants are recognizing the growing impact of brand names.  FALSE 11. Absolute values taken from financial statements are more useful than relative values.  FALSE     12. Ratio analysis can be useful for  A. historical trend analysis within a firm. B. comparison of ratios within a single industry. C. measuring the effects of financing. D. All of these are true.  13. In examining the liquidity ratios, the primary emphasis is the firm's  A. ability to effectively employ its resources. B. overall debt position. C. ability to pay short-term obligations on time. D. ability to......

Words: 5748 - Pages: 23

Premium Essay

Financial Management

...CHAPTER 14 FINANCIAL AND OPERATING LEVERAGE Q.1. A.1. Explain the concept of financial leverage. Show the impact of financial leverage on the earnings per share. The use of fixed-charges sources of funds, such as debt and preference capital, along with owners’ equity in the capital structure is known as financial leverage (or gearing or trading on equity). The financial leverage employed by a company is intended to earn more on the fixed charges funds than their costs. The surplus will increase the return on the owners’ equity. The role of financial leverage in magnifying the return of the shareholders’ is based on the assumptions that the fixed-charges funds (such as the loan from financial institutions and other sources or debentures or bonds) can be obtained at a cost lower than the firm’s rate of return on net assets. So, when the difference between the earnings generated by assets financed by the fixedcharges funds and costs of these funds is distributed to the shareholders, the earnings per share (EPS) (or return on equity, ROE) increases. EPS is calculated by dividing profits after tax (PAT) (net of preference dividend) by the number of shares outstanding. Example: All-equity Debt-equity 1. Investment 500,000 500,000 2. Equity capital 500,000 250,000 3. Debt capital @ 15% 0 250,000 4 EBIT 120,000 120,000 5. Less: Interest 0 37,500 6. PBT 120,000 82,500 7. Less: Taxes @ 50% 60,000 41,250 ------------8. PAT 60,000 41,250 9. No. of equity shares 50,000 25,000 10. EPS (5 ÷...

Words: 2444 - Pages: 10

Premium Essay

The Age of Gym Timeless Errors

...Costs: 1) Account Analysis 2) High-Low Method Contribution Margin: Sales -Variable Costs = Contribution Margin -Fixed Costs =Net Operating Income Used for external reporting Used by management Sensitivity analysis: if sales are down 10% or If sales are up by 10% what’s your income. Can be checked by CM Contribution Margin Ratio: Total CM/ Total Sales In terms of Units: CM Ratio: Unit CM/ Unit SP Break even point in Units Sold: FC/ CM per Unit Break even point in total sales dollars: FC / CM Ratio Operating Leverage: Degree of Operating Leverage = Contribution Margin/ Net Operating Income 1) 2) Variable Cost: Fixed Cost: Mixed Cost: with Variable and Fixed: cell phone bill which is $50 a month and additional 20 cents per message. Chapter 6: Cost Behavior: Analysis and Use LOOK AT CHAPTER 6 SLIDES Budget project: How many units do you need to break even. Also a cost volume profit graph. ON EXAM Mixed Costs Total Cost= Total fixed cost + Variable per unit * units ON EXAM: High-Low Method Ex: High hours of maintenance – Low hours / High Total Maintenance cost – Low Total Maintenance cost Predict Costs: 1) Account Analysis 2) High-Low Method Contribution Margin: Sales -Variable Costs = Contribution Margin -Fixed Costs =Net Operating Income Used for external reporting Used by management Sensitivity analysis: if sales are down 10% or If sales are up by 10%......

Words: 2418 - Pages: 10