Operating Leverage vs Financial leverage (Differences)
Operating Leverage vs. Financial Leverage – Leverage is a firm’s ability to employ new assets or funds to create better returns or reduce costs. That’s why leverage for any company is very significant.
There are two kinds of leverage – operating leverageOperating LeverageOperating Leverage is an accounting metric that helps the analyst in analyzing how a company’s operations are related to the company’s revenues. The ratio gives details about how much of a revenue increase will the company have with a specific percentage of sales increase – which puts the predictability of sales into the forefront. and financial leverageFinancial LeverageFinancial Leverage Ratio measures the impact of debt on the Company’s overall profitability. Moreover, high & low ratio implies high & low fixed business investment cost, respectively. .When we combine the two, we get a third type of leverage – combined leverage. Since both (operating leverage and financial leverage) are quite different, and we look at different metrics to calculate them, we need to discuss them in detail to understand them better.
- Operating leverage can be defined as a firm’s ability to use fixed costs (or expenses) to generate better returns for the firm.
- Financial leverage can be defined as a firm’s ability to increase better returns and reduce the firm’s cost by paying less taxes.
On the one hand, operating leverage compares how well a firm uses its fixed costs and financial leverage; on the other hand, it looks at various capital structures and chooses the one that reduces taxes most.
In this article, we at the comparative analysis of operating leverage vs. financial leverage.
Let’s get started with the head-to-head differences between operating and financial leverage in infographics without any ado.
Table of contents
Operating Leverage vs. Financial leverage Infographics
Let’s look at the top differences between operating leverage and financial leverage below –
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Explanation of Operating Leverage in Video
Operating Leverage vs. Financial leverage (Comparison Table)
Operating leverage and financial leverage are both critical in their terms. And they both help businesses in generating better returns and reduce costs. So the question remains: can a firm use both of these leverages? The answer is yes.
If a company can use its fixed costs well, it would be able to generate better returns just by using operating leverage. And at the same time, they can use financial leverage by changing their capital structure from total equity to 50-50, 60-40, or 70-30 equity-debt proportion. Even if changing the capital structure would prompt the company to pay interests; still, they would be able to generate a better rate of returns and would be able to reduce the amount of taxes at the same time.
That’s why using operating leverage and financial leverage is a great way to improve the company’s rate of returns and reduce costs during a particular period.
This article has guided the top differences between Operating Leverage vs. Financial Leverage. We also discuss the differences in operating leverage and financial leverage with examples, infographics, and comparison tables. You may also have a look at the following articles for gaining further knowledge in corporate finance –