INTRODUCTION

Leverage is generally defined as the ratio of the percentage change in profits to the percentage
change in sales. In other words, leverage is the multiplying effect that fixed costs have on profits
when there is any change in sales. As sales increases or decreases, it is only the variable costs
that change correspondingly, fixed costs remain constant. Profits therefore increase or decrease at
a faster rate than the rate of change in sales.
The two important points to be considered while making financing decisions are:
First, debt implies fixed financial obligations for the firm. After the firm breaks even, meaning
its earnings cover its debt obligations, any additional earnings will be distributed among
shareholders. Thus, when times are good and the firms earnings are high, debt financing results
in higher EPS. However, when times are bad and the firms earnings barely cover its debt
obligations, there is little left for shareholders and, thus, EPS is low under debt financing. This
relationship also shows that EPS exhibits a greater variation under debt as opposed to equity
financing in the two scenarios as can be seen from the results shown in the last table.
Second, stock financing does not dilute the shares of current owners. Therefore, in the boom
scenario, existing shareholders benefit from a higher EPS, but, in the bust scenario, they bear the
whole burden of the firms poor performance.
To the entrepreneur and corporate Liberalization, Globalization and Privatization are the
important issues threatening the existence of a firm. In such a complex corporate environment, it
is a challenge to the Finance Manager to survive the firm in long run perspective with the
objective of maximizing the owner's wealth. With a view to achieve this objective finance
manager is required to pay his due attention on investment decision, financing decision and
dividend decision.
Assuming that a sound investment policy and opportunity are in place, it is the intention of this
dissertation to optimize the financing decision and dividend decision in the context of achieving
the stated objective. Financing decision refers to the selection of appropriate financing mix and
so it relates to the capital structure or leverage.

Leverage is used to describe the firm's ability to use fixed cost to increase the return to its
owners. It is a tool for measuring Business Risk, Financial Risk and Overall Risk. A company's
long term debt in relation to equity is its capital structure. The larger the long term debt, the
higher the leverage. There are 3 types of leverages that are financial leverage and combined
leverage and operating leverage.
Financial Leverage* Operating Leverage= Combined Leverage.
Capital structure refers to proportion of long-term debt capital and equity capital required to
finance investment proposal. There should be an optimum capital structure, which can be
attained by the judicious exercise of financial leverage.
In order to run and manage a company, funds are needed. Right from the promotional stage,
finance plays an important role in a companys life. If funds are inadequate and not properly
managed the entire organization suffers, it is therefore necessary that correct estimation of the
current and future need of capital be made to have an optimal capital structure which shall help
the organization to run smoothly.
The capital structure is made up of debt and equity securities and refers to permanent financing
of a firm.
On the other hand a general dictionary meaning of the term Leverage refers to an increase of
accomplishing some purpose. In Financial Management the term leverage is used to describe the
firms ability to use fixed cost assets or funds to increase the returns to its owners.
This dissertation mainly concentrates on the study of effects of leverage on Manufacturing and
service sector firms.

LEVERAGE
Leverage is using given resources in such a way that the potential positive or negative outcome is
magnified in finance, this generally refers to borrowing. If the firm's Return On Assets (ROA) is
higher than the interest on the loan, then its Return On Equity (ROE) will be higher than if it did
not borrow. On the other hand, if the firm's ROA is lower than the interest rate, then its ROE will
be lower than if it did not borrow.
In other words, may be defined as, the employment of an asset or sources of fund has to pay fixed
cost or fixed return.
TYPES OF LEVERAGE
There are three type of leverage:
1.

Financial Leverage.

2.

Operating Leverage.

3.

Combined or composite leverage.

FINANCIAL LEVERAGE
Financial leverage is primarily concerned with the financial activities which involve raising of
funds from the sources from which a firm has to bear fixed charges. These sources include longterm debt (e.g.: bonds, debentures, etc) & preferential shares etc. Long-term debt carries a
contractual fixed rate of interest & obligatory. As the debt providers have Prior claim on income
& assets of a firm over equity shareholders. Their rate of interest is generally lower than the
expected return of the equity shareholders. Further, interest on debt capital is tax-deductible
expenses. These two-phenomenon lead to magnification of rate of return on equity capital &
hence E.P.S goes without saying that effects of changes in EBIT (Earnings Before Interest &
taxes) on the earning per share are shown by the financial leverage. Financial leverage can best be
described as the ability of a firm to use fixed financial charges in EBIT on the firm earning per
share.

Financial leverage helps to know the responsiveness of E.P.S. to change in the EBIT. It involves
use of funds obtained at fixed cost in the capital structure in such a way that it increases the return
for common shareholders.
It is referred to a state at which a firm has to bear fixed financing cost arising from the use of debt
capital. The firm with high financial leverage will have a relatively high fixed financing cost
compared with low financial leverage. Financial leverage occurs when a company employ the
fixed cost of funds debt or preference share capital with a view to maximizing earning available to
equity shareholder by a way of a higher income of funds. This technique also called Trade on
equity. Financial leverage influence the financial risk as long as the companys earning are
greater than its fixed cost it will enjoy a favorable financial leverage position and make earning
available to equity shareholders.
Financial leverage can measure with the help of the following formula:-

Financial leverage

EBIT
PBT

Financial leverage will have a favorable impact on earning per share a return of equity only. When
the firms return on investment exceeds the interest cost of debt it is favorable. The impact will be
unfavorable if the return on investment is less than interest.
The financial leverage measures the relationship between the EBIT & E.P.S. and it reflect the
effect of change in EBIT on the level of E.P.S. The financial leverage measures the responsiveness
of the E.P.S. to charge in EBIT If defined as degree of financial leverage% Change in EPS
% Change in EBIT
Degree of financial leverage

OPERATING LEVERAGE
Operating leverage associated with investment activities (Assets acquisition). It occurs anytime
when firm has fixed costs that must be met regardless of volume in operating leverage, when
fixed cost remains constant the percentage change in profit accompanying a change in
volume is greater than the percentage change in volume. A firm with high operating leverage
will have a relatively high fixed cost in comparison with a firm with low operating leverage. If a
company employs operating leverage then its operating profit will increase at a faster rate for any
given increase in sale. However, if sales fall the firm with high operating leverage will suffer
more loss than the firm with the no or low operating leverage. Therefore operating leverage
called 2-edged sword. It can be ascertained by the help of following formula

Operating leverage =

Contribution
EBIT

DEGREE OF OPERATING LEVERAGE

A high degree of operating leverage shows the greater impact on the operating income of
the company due to variability in its sales, which is also responsible for variability in its operating
profit. It is an important determinant of operation risk.It can be measured by % change in E.B.I.T.
due to percentage change in sale.
% Change in EBIT
% Change in sales
Degree of operating leverage =
Favorable leverage is said to occur when the firm earns more on the assets purchased with the
funds than their opportunity use. It is unfavorable when firm doesnt earn equivalent to the cost of
funds

COMPOSITE LEVERAGE OR COMBINED LEVERAGE OR TOTAL LEVERAGE

When financial leverage is combined with operating leverage the effect of change in revenues or
earning per share is magnified. Composite/combined leverage refers to extent to which firm has
fixed operating cost as well as financial cost.
The degree of operating and financial leverage can be combined to show the effect of total
leverage on E.P.S associated with given change in sales.
Operating and financial leverage together cause wide fluctuation in E.P.S. For given change in
sales if company employs high level of operating leverage and financial leverage even a small
change in level of sales will have a dramatic effects on earning per share
It can be calculated using the following formula;-

Combined leverage

Contribution
PBT

SIGNIFICANCE
A proper combination of both financial & operating leverage is blessing for the firms growth,
while improper combination of both leverages may prove curse for the growth of company. So
company should try to achieve balance of both leverages.

BHARTI AIRTEL

Airtel comes to you from Bharti Airtel Limited, one of Asias leading integrated telecom services
providers with operations in 19 countries across Asia and Africa. Bharti Airtel since its inception,
has been at the forefront of technology and has pioneered several innovations in the telecom
sector.
The company is structured into four strategic business units - Mobile, Telemedia, Enterprise and
Digital TV. The mobile business offers services in India, Sri Lanka and Bangladesh. The
Telemedia business provides broadband, IPTV and telephone services in 89 Indian cities. The
Digital TV business provides Direct-to-Home TV services across India. The Enterprise business
provides end-to-end telecom solutions to corporate customers and national and international long
distance services to telcos.
Airtel was born free, a force unleashed into the market with a relentless and unwavering
determination to succeed. A spirit charged with energy, creativity and a team driven to seize the
day with an ambition to become the most globally admired telecom service. Airtel, in just ten
years of operations, rose to the pinnacle to achivement and continues to lead.
As India's leading telecommunications company Airtel brand has played the role as a major
catalyst

in

India's

reforms,

contributing

to

its

economic

resurgence.

Today they touch peoples lives with their Mobile services, Telemedia services, to connecting
India's leading 1000+ corporates. They also connect Indians living in USA, UK and Canada with
callhome service.

Largest Private Integrated Telecom Company in India

3rd Largest Wireless Operator in the World

Largest & Fastest Growing Wireless Operator in India

Largest Telecom Company listed on Indian Stock Exchange

BHARTI AIRTEL
INCOME STATEMENT FOR THE YEAR 20015-2016
PARTICULARS
Sales
Less

Less

53237939.58

Contribution

47702379.42

Fixed Cost

Interest
Profit Before Tax(PBT)

Less

100940319.00

Variable Cost

Net Operating Profit(EBIT)

Less

AMOUNT

Tax Paid
Profit after tax or net profit

435869.00
47266510.42
1023137.36
46243373.06
42411.00
46200962.06

 CALCULATION OF VARIABLE COST

PARTICULARS

AMOUNT

1.

Consumption P. Material

47624207.10

2.

Consumption of R. Material

40126507.40

3.

Direct expenses

4.

Building repairs & maintenance

69711.00

5.

Charity & Donation

10401.00

6.

Conveyance

874481.00

7.

Electricity

172812.00

8.

Employee state insurance

27977.00

9.

Finance charges

99084.00

10.

Generator Fuel & rent

11.

Insurance

12.

License & other fee expenses

13.

Machinery repairs & maintenance

56671.00

14.

Maharashtra state labour welfare fund

30000.00

15.

Miscellaneous expenses

16.

N.I.T. Ground rent

17.

Postage

3265294.00

147855.00
52338.00
2084050.00

5996.64
20804.00
5906.00

18.

Printing & stationary

13648.00

19.

Provident fund

20.

Repair & maintenance

21.

Sample & chemical analysis

22.

State Ex. Escort charges

23.

State Excise charges

263691.00

24.

Sundry Expenses

266878.66

25.

Telephone expenses

35455.00

26.

Transportation expenses

95029.00

27.

Travelling expenses

155225.00

28.

Vehicle maintenance

163674.78

29.

Weight & Measure

153178.00
69187.00

87469.00

12610.00
Total

109599.00

53237939.58

CALCULATION OF FIXED COST

PARTICULARS

1.

Advertisement expenses

2.

Salary

3.

Sales promotion

AMOUNT
10456.00
413413.00
12000.00

Total

435869.00

CALCULATION OF TOTAL INTEREST

PARTICULARS

AMOUNT

1.

Bank Commission Interest & charges

58718.36

2.

Bank Interest

3.

Interest

61079.00

4.

Interest on VAT

40627.00

862713.00

Total

1023137.36

CALCULATION OF TAX PAID

PARTICULARS

AMOUNT

1.

Corporation tax

25278.00

2.

Sales Tax

17133.00
Total

42411.00

ADVANTAGE OF LEVERAGES
IMPROVEMENT IN CREDIT RATING
A firm that successfully uses leverage demonstrates by its success that it can handle the risks
associated with carrying debt. This can become an important factor when additional financing is
needed. Not only will loans more likely be available, but they will be available at more attractive
interest rates. Like individuals, companies with solid financials, but little credit history,
sometimes have trouble convincing lenders that they are deserving of a good rate.
CAPTURING ECONOMIES OF SCALE
Some activities become more efficient when conducted on a larger scale. Industrial mass
production is an example of such an activity. Generally, larger production facilities incur a lower
unit cost to produce goods. Since it is advantageous to the company both to offer many items for
sale and to compete by offering the consumer a lower price, larger facilities are often better. If
the firm cannot afford such a facility, borrowing may be the best solution.
INCREASED FREE CASH
By borrowing funds, the firm incurs a debt that must be paid. But, this debt is paid in small
installments over a relatively long period of time. This frees funds for more immediate use. For
example, if a company can afford a new factory, but will be left with negligible free cash, it may
be better to finance the factory and spend the cash on hand on inputs, labor or even hold a
significant portion as a reserve against unforeseen circumstances
TAX BREAKS
Another advantage of using leverage to finance business operations is that it provides tax breaks.
When you have to pay interest for business purposes, the Internal Revenue Service allows you to
deduct this on your tax return. The amount of the interest paid on the loan reduces the total
amount of taxable income for the business. Because of this, it also reduces the effective cost
associated with borrowing money for business purposes.

LESS FORMALITY
When compared with financing a business through equity, using debt is much less formal. When
you use equity to finance business operations, you have to issue shares of stock, hold shareholder
meetings and issue regular correspondence to all of your investors. By comparison, a loan is
much easier to deal with. You simply make a loan payment every month and the issue is handled.
If you would rather focus on what your business does best, leverage may be the best option.
RETAIN OWNERSHIP

One of the advantages of using leverage in your business is that it allows you to retain full
ownership over the company. When you finance business operations with equity financing, you
have to sell a portion of the ownership in your company. Because of this, you have to work in
conjunction with other business owners when making decisions. If you want full control over the
business, using leverage can provide you with this option instead of having to share control.
EVENTUAL REPAYMENT

When you use debt to finance business operations, you will have to repay the amount that you
borrow at some point. While this may be a temporary financial burden, you will eventually pay
off the debt. At some point, the loan payments will stop. If you use equity financing instead, you
will always have to share future profits with the other investors in the company. The investors are
never paid off unless you buy back their shares of the business.
POWERFUL ACCESS TO CAPITAL.
Financial leverage multiplies the power of every dollar you put to work. If used successfully,
leveraged finance can accomplish much more than you could possibly achieve without the
injection of leverage.
IDEAL FOR ACQUISITIONS,
Because of the additional cost and risks of bulking up on debt, leveraged finance is best suited
for brief periods where your business has a specific growth objective, such as conducting an
acquisition, management buyout, share buyback or a one-time dividend

.
DISADVANTAGE OF LEVERAGES

RISKY FORM OF FINANCE.

Debt is a source of funding that can help a business grow more quickly. Leveraged finance is
even more powerful, but the higher-than-normal debt level can put a business into too high a
state of leverageand that magnifies exposure to risk.
MORE COSTLY.
Leveraged finance products, such as leveraged loans and high yield bonds, pay higher interest
rates to compensate investors for taking on more risk.
COMPLEX.
The financial instruments involved, such as subordinated mezzanine debt, are more complex.
This complexity calls for additional management time and involves various risks.
FINANCING COSTS
As if these troubles werent significant enough, any leverage funding that is applied to your
positions must also be paid for in terms of interest. Interest is calculated and applied on a daily
basis depending on the relevant rate as set by your broker. These costs are obviously all the more
applicable with the high degrees of leverage involved in forex transactions, and the costs can
mount up to act as a disincentive for holding exposure long term.
MARGIN CALL RISK
At the same time, there remains the ever-present risk that you will fall below the margin
requirements established by your broker. This is the set percentage of any transaction size you
are required to fulfil in terms of your own capital, and if you fall below that threshold at any
point, you can expect your broker to instigate the margin call, which will automatically liquidate
your portfolio as far as meeting your obligations is concerned. This means that positions that
might run on to deliver vast profits are closed out early (posing extensive and unavoidable
opportunity cost) in addition to liquidating losing positions that might recover. Ultimately, this is
a constant risk that is posed by the presence of leverage, and something you should take care in
managing your capital to avoid.

CONCLUSION

EPS is high compared to other 2 firms and Airtel retained 100% of its earnings
during 2011-13 and hence could not pay any dividends to its shareholders during
that period
Airtel financed most of its assets using equity and Value of the company is high.
Profit Volume Ration of the company is increasing every year increase in profit
Margin of safety of the company is at the good position as it is increasing at every

year.
All the Cost analysis for company is states that the company is at good position.
The company has greater future prospective for expansion.
Company profitability providing good return to their owners
The profit generated by company profit is effectively invested in the company in
order to expand business.

.
.
.

BIBLIOGRAPHY

Maheswari S.N.: Financial Management 5th Edition

Annual reports of companies

www.investopedia.com
http://www.pdf-searcher.com/pdf/leverage-analysis.html
www.bhartiairtel.com
www.managementparadise.com
http://www.thehartford.com