Leverage is a very important and complicated term in Finance , Hope my this article help you to understand it much better.

Leverage

In very simple words Leverage measures the relationship between two financial variables. It generally represents the influence of one financial variable over some other financial variable.

There are mainly three types of Leverage

1) Operating Leverage

It measures the effect of change in Sales quantity on Earning before Interest & Taxes (EBIT)

formula =  Sales - V.C / EBIT

 Here V.C = Variable Cost (i.e Contribution)

thus it measures the impact of % increase or decrease in Sales on EBIT

2)Financial leverage

Here it indicates the extent to which the Earnings Per Share (EPS) will be effected with the change in Earning before Interest & Taxes (EBIT)

formula = EBIT / EBIT - Interest

thus a high degree of FL indicates indicate high fixed income earning of securities in the capital structure of the company.

3)Combined Leverage

Under Comibined Leverage its measure the effect of both Operation Leverage and Financial Leverage .

thus its formula is Sales - V.C / EBIT  * EBIT / EBIT - Interest