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What are the differences between Operating leverage and Financial Leverage?


Leverage is used to reduce the cost of a firm. There are three types of leverage in a firm that is operating leverage, financial leverage and combined leverage. The operating leverage helps to determine the operating cost associated with the firm. The operating leverage is an investment activity of the firm in which helps to ascertain the total cost of operating the business activities. The operating leverage is calculated with the help of earnings before interest and tax and sales.
The financial leverage helps to determine the financial risk in a firm. Using the debt instrument in capital structure to finance its business activity is known as financial leverage. The financial leverage helps to reduce the tax burden by paying interest on debt instrument. The interest amount is tax deduct-able.

Difference between operating leverage and financial leverage:
Point of difference
Operating Leverage
Financial Leverage
What is operating leverage and financial leverage?
 The operating cost for using the assets to generate sales is known as operating leverage.
In financial leverage using the debt in capital structure for which company has to pay interest on it.
Higher operating leverage and financial leverage
Higher operating leverage means company pays more fixed cost on using fixed assets. If the cost is high in comparison to the return in that case it is not good for company.
Higher financial leverage means company pays more interest for using more debt instrument in capital structure. If the leverage is high then the return of the shareholders is increases and the main motive of the company is to increase the shareholders wealth. So, the higher financial leverage is good for the company.
Business risk or financial risk
The operating leverage helps to determine the business risk in the firm.
The financial leverage helps to determine the financial risk in the firm.
How to determine the operating leverage and financial leverage?
With the help of cost structure company can find out the operating cost of the company.
With the help of capital structure company can find out the debt amount used in a company.
How to calculate operating leverage and financial leverage?
Degree of Operating leverage (OL) = percentage change in earnings before interest and tax (EBIT) / percentage change in sales
Or
Operating leverage (OL) = Contribution margin / operating profit
Financial leverage (FL) = earnings before interest and tax (EBIT) / Earnings before tax (EBT)
What is the motive of financial leverage and operating leverage?
Operating leverage helps to reduce the operating cost of the firm.
Financial leverage helps to reduce the tax burden of the firm.
What are the advantages of operating leverage and financial leverage?
It helps to reduce the operating cost of the firm,  
It helps to ascertain the cost structure.
It increases the earnings per share,
 It helps to maintain the existing shareholders in accompany.
What are the disadvantages of operating leverage and financial leverage?
If the operating cost is high then the business risk is also high.
It increases the burden of the firm; It increases the chances of default risk.



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