Fundamentals of Financial Management, Third Edition

SUMMARY

Leverage is used to raise profits and is therefore a tool of profit planning. Broadly speaking, there are three types of leverages. First, return-on-investment leverage which is brought into action either by decreasing the size of the assets so as to increase the asset turnover, or by decreasing the cost so as to raise the EBIT, or by incorporating these two methods at the same time.

Second, marginal-analysis leverage which takes the form of either operating leverage or fixed-charge leverage or a combination of the two. Operating leverage exists because of the existence of fixed operating costs. The greater the degree of this leverage, the larger is the change in the operating profit as a result of any change in the volume of sales. ...