Explain the impact of leverage on operating income and net income. Use a
real-world example to illustrate your thinking. If you were a company
owner, how would you utilize leverage?
U determine your company's cost structure. If the two companies have the same total revenue and total amount of expenses , the company with the highest proportion of fixed cost (verses variable costs) will have the greatest opeerating leverage. I would utilize leverage by balance operating income and net incomein my company.
Higher operating leverage is good when sales rise because net income rises faster than it would if you had lower operating leverage. Higher operating leverage has the opposite effect when sales decline because profits fall faster.
leverage impacts businesses in different ways depending on categories on net income the percentage of the involvement is required as in operating income it can help and hurt a business. for example For example, if your small business has a DOL of 7 and a 5 percent increase in sales, multiply 7 times 0.05 times 100 to get a 35 percent increase in net income. If you instead had a lower DOL of 3 and the same sales increase, your net income would rise by just 15 percent, or 3 times 0.05 times 100.
Operating leverage essentially measures the proportion of a company fixed cost structure and the switch in the sales volume that can affects the company profit.
You're right but you also know that operating income is also all about what the investor makes as the profit, and what is included or not included from that profit.
Depending on the company, leverage can make positive or negative impacts. Increased leverage may increase profitability but can also increase it's risks. Companies with high operating leverage have high fixed costs and low variable costs; and vice versa with companies having low leverage. An example of a company with a nice ratio is Walt Disney. its 2.1 ratio means that for every dollar the firm had $2.10 in assets. The financial leverage has more risks but successful use will increase return on equity.
A business with higher operating leverage has higher fixed costs than variable costs. Fixed costs remain unchanged regardless of sales. Variable costs fluctuate with sales. Net income equals sales minus variable costs minus fixed costs.
You're right on target for every amount of dollars that make they get profit but always remember it a certain limit that they have to keep their profit under or they will have to pay taxes on the money they earned, especially if they are investing all of their own equity.
The different between leverage on operating income and net income are both of them are uses for good causes within the company. For example operating income is like a fix income uses to run the business with before all the expensive, and taxes deducted and net income is after all the deduction taking out from the profit and left with the remaining.
Return on equity measures net income, or profit, as a percentage of stockholders’ equity. A higher ROE means a business generates more profit per dollar of equity. Operating leverage measures how much a company’s net income changes based on a change in sales. If your small business has high operating leverage, a small change in sales leads to a greater change in net income, which leads to greater fluctuations in return on equity. An example would be if a put down a payment on a house or business.
According to most companies operating income is the way that an investor tell how much they will or can profit from a particular company, however net income is the overall earnings that the investor makes after expenses and taxes are paid. I'll utilize this leverage by making sure that I borrow more than I invest in order to profit more and not have to pay as much for taxes.
Leverage results from the use of fixed cost assets or funds to magnify returns owners. Leveraging is important in evaluating a business. Business have to decide how leverage they want to be and just as in the securities markets, increased leverage increases potential profitability and potential risk. Financial leverage is a concept that anyone with a home mortgage can relate to. a home buyer who puts 5000 down on a 100,000 house has a financial leverage ratio of 20. For every dollar in equity the buyer has 20 dollars in assets.
I posted originally and it was much extremely longer so I'll have to be more brief. Basically, if you choose to use operating leverage you can affect the possibility of having more profit whereas, not using any operating leverage can mean that there's less profit in the end because of all the other inquired capital costs like price of production.
The impact that leverage on operating income and net income has on a firm is the difference in return on investment. For example, if a company is using equitiy finance the more than likely have a higher leverage on operating income. If they are using financing the return will be lowered. The book uses an example of an airline company and a retail company showing the difference in leverage how it works in different industries.
Operating income will rise and fall more faster for a company with operating leverage. The airline industry is a good example of an industry that has a large amount of operating leverage, due to fixed costs. The retail industry has fewer fixed costs, and many variable costs. As the company expands output, these variable costs also expands.
that's definitely true because with a fix cost in a company in the company really not making any money and fix cost is hurting the company because the price of the product stay the same is not really going up so the company is not making a lot of money at all.
Leverage is categorized by the use of borrowed capital (debt or equity) to increase the potential return of an investment. A firm with significantly more debt than equity is considered to be highly leveraged. Operating leverage measures a company’s fixed costs as a percentage of all of its costs. Operating leverage is important because it is an indicator of the quality of earnings of a firm. To calculate operating leverage, divide contribution margin by its net operating income. a decrease in the ratio of net income to fixed costs may indicate lower earnings quality because higher fixed costs may result in greater earnings instability.
One way a company might use leverage is to sell stock for equity and then take a loan out from a bank to finance new projects. This is has proven to be a useful way of gaining capital to finance current projects that will lead to future profits.
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ReplyDeleteHello!
ReplyDeleteU determine your company's cost structure. If the two companies have the same total revenue and total amount of expenses , the company with the highest proportion of fixed cost (verses variable costs) will have the greatest opeerating leverage. I would utilize leverage by balance operating income and net incomein my company.
ReplyDeletegreat idea using leverage in this way is a good choice
DeleteHigher operating leverage is good when sales rise because net income rises faster than it would if you had lower operating leverage. Higher operating leverage has the opposite effect when sales decline because profits fall faster.
DeleteLeverage is any technique that amplifies profits or losses. It's most commonly used to describe the use of borrowed money to magnify profit potential.
DeleteLeverage is concerned with assets to equity. an increase in leverage, results in increases in potential profits and potential risks.
ReplyDeletegreat answer, it is very simple and straight to the point
DeleteHi Ms. Lawson leveraging is important in assets to equity. The more leverage you have the results will increase or create problems.
DeleteVery good assessment Barbara....i agree
DeleteGreat answer Jennifer! As a business owner increase profit is something I would want to see with my business.
Deletetest
ReplyDeleteleverage impacts businesses in different ways depending on categories on net income the percentage of the involvement is required as in operating income it can help and hurt a business. for example For example, if your small business has a DOL of 7 and a 5 percent increase in sales, multiply 7 times 0.05 times 100 to get a 35 percent increase in net income. If you instead had a lower DOL of 3 and the same sales increase, your net income would rise by just 15 percent, or 3 times 0.05 times 100.
ReplyDeleteOperating leverage essentially measures the proportion of a company fixed cost structure and the switch in the sales volume that can affects the company profit.
ReplyDeleteYou're right but you also know that operating income is also all about what the investor makes as the profit, and what is included or not included from that profit.
Deletegood simple way to explain, thank!
DeleteToo much leverage can be bad because it puts the company at more risk. No matter what its use, leverage can be a powerful tool when used responsibly.
DeleteDepending on the company, leverage can make positive or negative impacts. Increased leverage may increase profitability but can also increase it's risks. Companies with high operating leverage have high fixed costs and low variable costs; and vice versa with companies having low leverage. An example of a company with a nice ratio is Walt Disney. its 2.1 ratio means that for every dollar the firm had $2.10 in assets. The financial leverage has more risks but successful use will increase return on equity.
ReplyDeleteA business with higher operating leverage has higher fixed costs than variable costs. Fixed costs remain unchanged regardless of sales. Variable costs fluctuate with sales. Net income equals sales minus variable costs minus fixed costs.
DeleteYou're right on target for every amount of dollars that make they get profit but always remember it a certain limit that they have to keep their profit under or they will have to pay taxes on the money they earned, especially if they are investing all of their own equity.
DeleteThat was a great example of leverage in a real world scenario. After today's practice quiz, I understand leverage even more
DeleteThe different between leverage on operating income and net income are both of them are uses for good causes within the company. For example operating income is like a fix income uses to run the business with before all the expensive, and taxes deducted and net income is after all the deduction taking out from the profit and left with the remaining.
ReplyDeleteI believe if a company is using financing it can probable deter investors away depending on how much financing they are using.
DeleteReturn on equity measures net income, or profit, as a percentage of stockholders’ equity. A higher ROE means a business generates more profit per dollar of equity. Operating leverage measures how much a company’s net income changes based on a change in sales. If your small business has high operating leverage, a small change in sales leads to a greater change in net income, which leads to greater fluctuations in return on equity. An example would be if a put down a payment on a house or business.
ReplyDeleteTrue, because with financing the firm will pay off debt then investors which would lower the return.
Deletewhen you have return on equity the company tend measured different area better and learn to be more flexible for future need
DeleteAccording to most companies operating income is the way that an investor tell how much they will or can profit from a particular company, however net income is the overall earnings that the investor makes after expenses and taxes are paid. I'll utilize this leverage by making sure that I borrow more than I invest in order to profit more and not have to pay as much for taxes.
ReplyDeleteGood answer Mr. Hudson! Borrowing more than you invest in order to gain a profit is a smart way of obtaining more of a profit.
DeleteLeverage results from the use of fixed cost assets or funds to magnify returns owners. Leveraging is important in evaluating a business. Business have to decide how leverage they want to be and just as in the securities markets, increased leverage increases potential profitability and potential risk. Financial leverage is a concept that anyone with a home mortgage can relate to. a home buyer who puts 5000 down on a 100,000 house has a financial leverage ratio of 20. For every dollar in equity the buyer has 20 dollars in assets.
ReplyDeleteThis comment has been removed by the author.
ReplyDeleteI posted originally and it was much extremely longer so I'll have to be more brief. Basically, if you choose to use operating leverage you can affect the possibility of having more profit whereas, not using any operating leverage can mean that there's less profit in the end because of all the other inquired capital costs like price of production.
ReplyDeleteThis comment has been removed by the author.
ReplyDelete
ReplyDeleteThe impact that leverage on operating income and net income has on a firm is the difference in return on investment. For example, if a company is using equitiy finance the more than likely have a higher leverage on operating income. If they are using financing the return will be lowered. The book uses an example of an airline company and a retail company showing the difference in leverage how it works in different industries.
Operating income will rise and fall more faster for a company with operating leverage. The airline industry is a good example of an industry that has a large amount of operating leverage, due to fixed costs. The retail industry has fewer fixed costs, and many variable costs. As the company expands output, these variable costs also expands.
ReplyDeletethat's definitely true because with a fix cost in a company in the company really not making any money and fix cost is hurting the company because the price of the product stay the same is not really going up so the company is not making a lot of money at all.
DeleteLeverage is categorized by the use of borrowed capital (debt or equity) to increase the potential return of an investment. A firm with significantly more debt than equity is considered to be highly leveraged. Operating leverage measures a company’s fixed costs as a percentage of all of its costs. Operating leverage is important because it is an indicator of the quality of earnings of a firm. To calculate operating leverage, divide contribution margin by its net operating income. a decrease in the ratio of net income to fixed costs may indicate lower earnings quality because higher fixed costs may result in greater earnings instability.
ReplyDeleteOne way a company might use leverage is to sell stock for equity and then take a loan out from a bank to finance new projects. This is has proven to be a useful way of gaining capital to finance current projects that will lead to future profits.