Notes were compiled in 2018 based on the 2018 scope and expected outcomes hence adjustments may need to be made for adjustments in the scope or learning outcomes for the current year.
• Leverage = Use fixed costs/ funds to maximise returns
• Capital structure is how a firm finance operations with a mix of debt(D) and equity (E).
• More debt than equity result in increased leverage,
o results in higher returns but the downside is higher risk
o Directly impacts financial leverage
• 3 types of leverage
o Operating leverage: relationship between Revenue &EBIT
o Financial leverage: relationship between EBIT & EPS
o Total leverage: relationship between Revenue & EPS
General statement of comprehensive income format and types of leverage
Revenue
Less: Cost of goods sold
Operating leverage
Gross profit
Less: Operating expenses
Earnings before interest and taxes (EBIT)
Less: Interest
Net profit before taxes Total leverage
Less: Taxes
Financial leverage Net profit after taxes
Less: Preference share dividends
Earnings available for ordinary shareholders
Earnings per share (EPS
Break-even analysis/CVP analysis
• Operating break-even point = Determine how many units need to be sold to cover costs (both fixed and
variable costs)
o Point at which EBIT = R 0
o Evaluates profitability associated with various levels of sales
• CVP = cost-volume-profit
• Important to understand & split costs between FC and VC
• Fixed costs are function of time
o are constant in total
o Example: contractual rent
• Variable costs are a function of volume
o are constant per unit
o increase in total (will increase based on the number of units sold)
o Example: material and labour directly linked to product
• Sensitivity of operating break-even point:
o Increased fixed operating cost (FC) = increase operating break-even point
More units need to be sold to cover FC and VC to make zero profit
o Increased sale price per unit (P) = decrease operating break-even point
Less units need to be sold to cover FC and VC to make zero profit
o Increased variable operating cost per unit (VC) = increase operating break-even point
More units need to be sold to cover FC and VC to make zero profit
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