Leverage - Explained in Hindi - YouTube

Subscribe to Asset Yogi channel and press the bell icon

to watch the latest finance videos

Hello. My name is Mukul and you're welcome to Asset Yogi.

We're going to discuss leverage in this video.

A lot of subscribers had requested in the past to make a few videos on leverage.

So we'll do a small series of 3 videos

In this video, we'll discuss the concept of leverage,

and in the upcoming two videos, I'll discuss operating leverage

and financial leverage in detail.

And when we talk about the concept of leverage,

so its concept originates from science.

If I tell you in simple language, leverage is such a tool,

which makes our work easier.

This means when we talk about higher leverage or when we increase lever

That means we have to put less effort and we get more output.

So when we apply the same concept in finance,

so first is operating leverage cause of the cost structure

and second is financial leverage cause of capital structure.

Now, the operating leverage is a fixed cost

For any business which has a high fixed cost, we'll say that the

company has high operating leverage.

Similarly

In any financial leverage

your debt or loan is your financial leverage.

So if a company has taken a big loan

so that means they are using someone else's money.

They have to put in less effort and they might get more output

so that is the degree of financial leverage.

High operating leverage definitely has benefits, as well as drawbacks

and Higher financial leverage has benefits and drawbacks

Now what effects do high operating and financial leverage

have on sales and profit?

We'll understand that in this video

so make sure to watch this video till the end.

Let's learn the concept of leverage at first.

Let's assume you want to lift a load. You install a beam like this.

The point where it touches the beam, is called fulcrum.

So if you apply the force here, you can lift the load

But let's say the force you're applying is not sufficient.

In that situation, you can do two things to lift the load

One is that you can increase the force

Or you can shift the fulcrum here. If you shift the fulcrum here

So we'll get a situation like this.

So what will happen in this case? Here the lever 'l' which is

the distance between F and fulcrum. It was short

and in this case, the 'l' lever is increased

So when there is lower leverarge, it means you have to put in more efforts

you'll have to apply more force to lift the weight.

Now that you have increased the leverage,

the force you have to apply here is less.

It may be that you have to apply F/2 force instead of F

and it's also possible that you might lift more weight

I am not going into exact formula that exactly how much weight

you'll get to lift or the exact force you'll have to apply.

Mainly we want to understand that in lower leverage we have to

put in more effort and the output gained is less

and when we increase leverage, we have to put in less effort

and we get more output from it.

Now the same concept is applicable in finance.

So one we have our operating leverage

operating leverage

depends on what kind of cost structure the company has.

Second is the financial leverage

it depends on how the company has used its capital structure

what portion of it is the debt or loan that have taken

and what portion they have used their equity capital.

So the lever in the operating leverage, and the leverage we're talking about here

that is our fixed cost.

So if the fixed cost is high in any company or industry

that means we say it's opertaing leverage is high.

The lever in the financial leverage

that is basically our debt, which means the loan

that how much loan has the company taken

So the higher your debt or loan is, the higher your financial leverage will be.

Now let's understand the concept in detail

So how are these high operating leverage companies?

We take the example of the Airlines industry

Fixed costs are very high in it

Let's see what are the fixed cost.

The company can either purchase the aircraft or take it on the lease,

it's a fixed cost. So money is definitely spent on it each month

whether the passengers come or not.

Now the hangar, where the airplane is held,

there will be some lease of it, it's also a fixed cost.

Company would have insured the airplanes, so it's a fixed cost.

So the fixed costs are very high in the Airlines industry.

What are variable costs?

Like jet fuel, if the plane does not fly, fuel won't be used,

there will be no runway charge. So these are variable costs.

So the fixed costs are very high in the Airlines industry.

So when the fixed cost gets high, we say that operating

leverage of the company has increased.

So in the calculation, we calculate the degree of operating leverage.

If the degree of operating leverage is two times,

what does that mean? It means if sales increase by 20%

then the operating profit increases by 40%,

but it's a double-edged sword

if the sales in it become -20%

then your operating profit will be -40%.

So here, if the operations are going well, it's a very good thing.

So these kind of companies do very well if the market is good.

If by chance there is a recession, then there is high operational

risk. If sales drop even a little then operational profit

starts to decrease drastically.

On the other side if we talk about low operating leverage companies,

in it, the degree of operating leverage is quite low.

For example, there is a consulting or service industry,

what are the fixed costs in it?

Wherever company has opened the office, its rent,

Electricity bill, water bill, all the fixed bills like these.

Variable costs are high for these, mainly salaries.

So the salaries of the people working there are the main cost.

So these kind of companies increase or decrease their workforce depending on the market condition.

So here the flexibility is high.

So that's why, when we say our degree of operating leverage

is high, which means the operational risk of these companies is high.

So we talked about operating leverage here.

In this video, we're talking about the concept only.

How do we do the exact calculation?

What's the formula for degree of operating leverage?

I'll tell that in the next video.

Now, let's talk about financial leverage.

When we say a company is a high financial leverage company,

so let's say in real estate, companies have to take a lot of debt.

Assume we have to make a building and rent it,

people do not prefer to use their own money, they prefer to

use bank's money, so their returns can get better.

So what happens in it?

If your Return on Investment is greater than whatever the interest you've taken from the bank,

then the company can grow rapidly.

For example. if the return on investment comes to be 20%

In a real estate company, let's say rent is very good from a particular location

and the company is getting a great total return on investment,

and it has to give only 12% interest.

So this net +8%, company is earning it from outside only.

It's using bank's money at 12% and is earning 8% from outside.

But in bad market conditions, it can be the opposite,

because it definitely has to give 12% interest to the bank.

So if the return on investment falls below the interest,

then company can go bankrupt, it can fold up very fast.

Let's say the return on investment is 6%

but interest is still 12 %,

then this -6% difference, promotors or company will have to give from their own coffers or wallet.

That's why high financial leverage companies

grow very fast in good market conditions.

If market conditions are bad, that can be very dangerous

and it might cause bankruptcy for the company.

In today's date, a lot of real estates companies are about to be

bankrupt and its main reason is that their debt has increased

a lot. That's why high financial leverage companied have high

solvency risk. It got hidden here.

Basically, I'm talking about solvency risk and bankruptcy.

So chance of bankruptcy increases if market conditions are bad.

Now let's talk about low operating leverage companies.

In low operating leverage company, you can take example of

software industry. Software industry is also a service industry.

In it, you don't need to take a lot of debt.

people take only working capital loan sometimes.

So basically the loan is zero or very low.

We can call it negligible relative to company turnover.

So even if the return on investment decreases

generally return on investment does not decrease in service

industry, but by chance even if it decreases

Assume a product company.

Let's say it makes a product, its initial costs turn out to be high,

because it hasn't taken a loan, even if the return on investment is low, it will survive.

Let's say the return on investment is only 6%

even then it'll survive, but here the company which has high

debt, it won't be able to survive because it's paying 12% interest.

That's why solvency risk is less of low operating leverage companies.

So we've understood the basic concept of operating and financial leverage.

Now in upcoming videos, I'll tell you the calculation of both

and how we exactly calculate. So surely watch the next video.

I hope you liked the video. So make sure to like and share the video.

If you have any suggestions or you want to suggest a topic for

future videos, so you can do that in the comment section.

I come up with interesting finance videos like this daily,

so if you still haven't subscribed to the channel, so subscribe

from down below and press the bell icon on your phone

so you can get the notification for my latest video.

So let's meet in the next video. Till then,

keep learning, keep earning, and as always be happy.