Financial leverage is the use of debt to amplify returns for equity shareholders, similar to how a gear mechanism accelerates force without additional effort. When a company raises capital through both equity and debt, the debt portion generates interest that is then invested at the company's return rate, creating additional returns for equity holders. However, this same mechanism amplifies losses when sales decline, making it a double-edged sword. Companies with high operating leverage (high fixed costs) face greater business risk, while those with high financial leverage (high debt) face greater financial risk. The safest combination is low operating and low financial leverage, while the most dangerous is high operating and high financial leverage. Essential commodity businesses can afford more fixed costs, while discretionary businesses should minimize them to avoid losses during sales downturns.
CA INTER - CONCEPT ORIENTED BATCH - DAY 24
Added:Read the concept.
Just revise for 2 3 minutes. Concepts of leverages from the beginning.
So now the live students can please confirm whether I'm audible How are thing you did not understand. I give time for you to read.
You know how your perform will be.
Everyone know now how you will perform when I ask question.
So in advance I'm giving you time. Read properly or else you know about history.
Read Study we discussed about inverse relation between margin of safety and operating leverage. You all remember today questions like if you do mistakes then I will share see whatever the points are there everything I already discussed in the last class there is no nothing no new formula is pending for the today's class today's class if there is any pending from my side that is only two things number one understanding financial leverage I did not tell you I just told you the formula concept I did not tell you I mean not just that leverage is concept I did not discuss with I just told you the formula formula analysis we have done but in specific what is leverage all these things I did not discuss with you that we will do 100%. Okay. But formula, derivations, everything already we completed in the last class itself. Please write properly. See n if there are 10 questions in 10 on 10 will be dependent on only those formula.
But the twist questions in exam very well. So that is all we will do. But please read all the questions. Sorry I mean read all the formula clearly starting from the income statement.
Again I'm telling you leverage the chapter. The most important thing is income statement understanding important very very important for leverage chapter. Okay.
If you are clear we can start with the understanding concept of leverage. Shall we?
Have you read till then? Uh take 2 minutes. No problem. You take time and read not a problem but please read it carefully.
Okay.
Can we continue now? No. Now see see here.
Let me first explain what is the concept of leverage.
So uh this can be understood in two ways. Listen listen please.
Leverage concept we have to understand in two different ways.
Once you understand the concept of leverages you will definitely have a different approach when you read costing subject as well. So very practically your approach will change. You will understand things going around the cost thing also. But that is for sure once after listening to the finance way of leverage. See what is the concept of leverage.
Leverage in another way will be called as advantage with no additional effort.
Repeat what is leverage?
Advantage with no additional efforts means we don't put any additional effort but without putting the efforts without putting the efforts if there is any additional advantage that is flowing into the organization. We call such a situation as leverage.
Leverage is an additional advantage with no efforts extra efforts. Okay. example I will give you see here whenever we are riding a gear bicycle gear bicycles are then gear cycles what is the logic of a gear gear concept is very simple see I said with no additional efforts I'm not telling with no efforts additional efforts are not required what happens when you are riding a gear cycle till you will first pedal it to some extent at least reach at 10 or 15 kmp. Once you reach at that stage you need not do or put any additional efforts. The moment you change the gears automatically that the thrust will be created. Are you listening?
The speed will automatically increase.
That's called as a gear. Gear always accelerates the force without putting any additional efforts.
See even in car how it work how it works car or a bike whatever the case may be first time when you start the engine immediately if you put on 50 g it won't run you understand or not slowly it should accelerate itself after that you need not put any additional effort with a small acceleration speed automatically gains a times faster than that yeah so that's a work of a gear that gears are there also in finance I'm not joking name is called as Capital gearing ratio.
What is the name? Capital gearing ratio ratios. One of the most important ratio.
Capital gear. Capital gear means financial leverage. Financial leverage.
Another name is capital gears.
The first point clearly here. What is the gear? Something which creates acceleration without additional efforts.
something creates additional acceleration without additional efforts. You need not put any additional effort. See, I will give you an example here.
When you are going from a top to down on a cycle, your efforts will be very less but force will be very high. Clear? Huh?
Because there thrust is created. A gear has operated automatically. There the gear is a air automatically pushes you downward with no additional efforts. You are moving down.
company also has gears. You have to change the gears in a proper way. Who can change the gear properly? That's called as a charted accountant. These people will know about where we need to operate the gear, where we need to accelerate. I'm talking about companies.
Clear? Company finances also should be driven carefully like a car. So these CFA professionals, CH professional, these people will become CFOs in a company who will operate the gears of a company in a proper way by understanding the capital structure. So I will give you another example for you to understand. Listen general example.
Normally there are two persons. Let us say let us change an example. One person is 3540 kes.
Another person is say let us example 70 to 80. Are you understanding?
Normally this 3540 kes fellow can't lift to this 80 kes person.
Understood.
>> But on a seesaw he can do that.
You understand the point what I said on what he can do. You know sees what is a seis park it will be available.
Okay. On a play park if it is available or not. Two people one will be sitting on one side and will be sitting on the other side. Lowest pressure also will move that particular other person upwards. Correct. How come it is possible? Middle there is a leverage.
That's called as a lever in physics.
L are you understanding? Levers. Leos is a game s answer my question see I will give you an example please please please listen first there is a seesaw on a slanting position person one is sitting here person two is sitting here clear everyone now how they will imagine how that particular cesa stand will be there will be exactly in the middle there will be a rod attached to the earth directly.
One person will be pushing the force to the downward side. One person will automatically go to the upward side.
Normally you think I can go up to 6 ft high. I can go up to 6 ft high.
Other person on the other side is 35 40 kes. Me sitting on other side is 70 kes.
Normally he can't lift me even one in.
You listening? uh not in directly 6 ft he made me to uh uh jump upwards that's not because of his efforts without putting any additional effort this labor help him to do that this is the lever now take an example this way common sense again this liver I kept here this is the earth face. Now tell me, can you lift this person now easily?
Answer. Uh okay sir. I will ask you another question. This I kept here like this.
Can this person lift this fellow now?
Now now 80 kgs fellow also can't lift a 10 ks person. They answer properly.
This is exactly we call as a lever.
Lever is there in all the two cases. See three situations I said lever is there here. Lever is placed here. Lever is placed here. Now one by one you tell me here if I place the lever can person one take the person to upwards. Answer here if I keep can person two lift person one if here correct placement if I keep can person one lift person two or not one can lift two can lift one irrespective of their weights who helped one did not help to two did not help one who helped whom lever helped right placement of the liver help them to move upwards and downwards without putting any additional effort. Basic effort is required.
Additional efforts what you generally do to lift a person is not required when a river is placed in middle clearing the gravity will take care.
Okay. Why I'm telling all these things these all concepts are there also in finance. Till now what we discussed is a basic physics though we did not discuss anything in detail in formula. This is basic physics of gravity. So gravity always have some dynamics. It will pull it down. You will come down that person will come up. Additional thrust and force is not required. Basic lever same in company also. But this lever is the debt.
Liver is what?
>> Bad response. Lever is what?
>> Instead of this lever rod, we will have debt in the company. Debt works as a gears. Debt works as a >> loudly. That works as a >> how sir that will work as a lever. Can you please explain that? I'll explain with a super example. Tell me there is a company one. There is company two. Company one is a all equity company. Company one is a what you mean all equity company there is no debt 100% >> 100% >> equity shareholders say there is no debt allowed into the company. There are so many India biggest company TCS is a no debt company. It is there very very negligible you can call it all equity company.
It is there for name sake it is there.
See equity capital of equity capital of TCSC is four lakh crores.
How much?
>> Four lakh crores. Not four lakh not four crores. 4 lakh crores is a value of equity of TCS debt value is 750 crores or what is the comparison you understand not even 0.001% negligible portion of debt they are having when you compare with the market value of equity come back tell me what is the nature of company one all equity company two is equity and debt company two is Company 2 is a >> very good. Now see let us take same facts but we will prove that speed of company 2 is better than speed of company one.
What I said >> here what is the speed? Return is the speed. What is the speed yet?
>> Returns they generate is the speed here for us. Let us see this particular company one is a all equity company a debt and equity company raised 100 rupees from the shareholders raised 100 rupees from the shareholders okay invested at 16% return tell me you are all equity shareholders from you how much I have taken >> answer investor not investor invested at a place which gives me how much return?
>> Loudly.
>> Means at the end equity shareholders are receiving how much?
At the end equity shareholders are receiving how much? 100 rupees they have given how much you are going to give them back 100 forget return. I'm asking how much you are giving them?
>> Very good. Up to here everyone understood? Let us see the second case.
Tell me second case I have taken money from equity and debt are both now same 100 I have taken but I did not take from equity only I have taken from equity and debt equity 50 rupees debt 50 rupees listening debt gave me at 8% that gave me at how much% here >> 8% equity anyway K they will be expecting finally we will be discussing about them. Please answer. Second company, company two is all equity. Both equity as well as data.
>> How much money raised? How much is the equity part?
>> How much is the debt part?
>> In that 50, how at what rate I raised that 50 loan rate, interest rate, KD?
How much?
Answer everyone.
I have written real what is written? How much I have raised?
How much I have raised? You are not listening to the question. How much I raised in that? How much is equity? How much is debt? That 50 I raised free of cost at a costa.
>> How much cost?
>> Okay. Now tell me this 50 this 50 totally how much I invested at 16%. Same facts are same.
Are you listening? Now tell me you think and answer.
First mentioned company 100 rupees raised from equity 100 rupees raised from >> equity.
>> Equity. So how much they got?
>> How much they got?
>> 15.
>> Now how much I have taken from equity?
>> Totally.
>> 50. This 50 also invested what rate?
>> You calculate 50 into 16%. How much? 8 rupees. Correct.
Okay. Uh tell me this 50 into give uh this 50 into 16% how much I got loudly sir.
>> 8 rupees I up to here everyone understood clearly. Yeah. Next question for you that how much invested this 50 also will give me another 8 rupees or not? Okay. This 50 also this 50 also gave me another 8 rupees.
Totally how much I got?
>> Louly sir?
>> 16.
>> 16 I have got first case how much I received?
>> Second case how much I received?
>> 60. Now I will ask a question. You may not both sid same. Now listen I did not complete the question. My point is my point is in the previous example equity shareholders you received how much here how much you received if if here also I raised only 50 how much I will receive >> loudly >> but now see the other side of the story debt from debt I have taken how much >> 50 >> huh 50 >> 50 I have taken correct at what rate I have taken How much?
>> Very good. Now I'm talking about debt only. You please tell me second case.
Company 2 you think and answer. Equity shareholders gave how much principle?
>> Delay again. Equity shareholders gave how much money?
>> On this 50 how much you gave?
>> Very good. Debt gave you how much?
>> Eight.
>> 50. How much you should give them back?
50 into 8% you compute how much it is four rupees you have to give them how much equity given >> debt given 50 >> loudly >> okay on this 50 on this particular 50 how much you receive >> on this 50 how much you receive start again that is your concentration start See there company one company two see the biggest punishment is repetition at least that way you'll remember you will listen or else your mind will go I know about you see that start again there is company one change the example for your convenience much more simpler way I will explain raised from equity 50 rupees Okay. Invested at 16%.
Generated return of 8 loudly.
Forget about first company. Next this company raised equity again 58 r. It did not raise even one rupee extra.
Okay. Again invested how much percent.
Again received how much? But this company also have some debt. This company also have some Yeah.
>> From debt it raised another 50. Raised another >> 50.
>> 50. Okay. Now tell me this 50 taken at 8% invested at 16%. Tell me how much I have taken.
>> Bad response. How much I have taken?
>> How much I have taken? Listen to the question.
At what rate I did not ask? Listen carefully. Mind work. I'm asking how much at what rate both are different I'm asking how much you have taken from that is a question why 8% is coming as an answer a mental brain won't work properly see there how much I have taken from debt >> 50 rupees I have taken at what rate now tell the answer now you will tell 50 at what rate you have taken At what rate you invested?
Uh now see both the situations independently separately. First case of company only equity equity and data.
>> How much you have taken?
>> How much return generated?
>> Amount is how much?
>> 50 became how much? 58. I write like that. 50 became how much?
>> 58.
>> Now come to the second one. One time if you understand the complexity after that you will not get a doubt. Second case how much you have taken again from equity >> 50 at what rate you invested?
>> 16%. How much you receive?
>> Again total how much it is?
>> But don't stop there. In this company only equity is also debt is there.
Answer sir also debt is there. How much you have taken from debt? 50 taken at what?
Therefore you invested again at watering 16.
>> 16% means how much it will give >> again how much it will be.
>> But this 58 does not belong to you. 58 is a debt. You have to give there 50 and you also have to give the return back.
Answer everyone.
>> How much debt has given?
>> 58.
>> Our s outsiders sir can be kept should be returned back.
>> How much I need to return first? 50 >> only 50 also there interest how much interest I should return back eight >> how much I should return back >> four how much I receive >> how much I return >> extra how much is there >> four >> taken by equity became totally 62 this is how the leverage works do you understand the point or not mean I did business with some other money and I made more gain out of it which adds see Did equity shareholders put any additional effort in this? Do you understand my point? Huh? Did equity shareholders kept any additional effort?
What is their normal return?
58 is not normal return. You did not understand my question. What is their total realization? I did not ask 50 rupees they invested in first company.
Correct. Same 58.
Tell me what is the capital in company one?
Capital is in company 2.
>> Wrong. 50 in that 50 will be returned back anyway.
150 permanent capital. Another 50 is only for one year.
Hey, answer everyone start again.
Company one, what is the cap permanent capital?
>> Second company >> also 50. Second company, the debt taken and debt given back. It's not in the capital by the end of the balance sheet that is not even there. We repaid back the loan.
So now tell me company two you talk about how much is equity fund invested at what rate?
How much money came?
Total realization >> 50 became >> first company 50 became >> up to there everything is looking alike but company two another magic is there there are gears in company two listening tell me I took how much from debt >> that is ours should be returned back >> so that is not our money anyway okay 50 taken their money is taken at what rate how much they expecting how much They are expecting 8% means how much money answer >> four >> after one year I should give four 54 >> that 50 rupees I kept it idle or invested >> invested >> invested what rate >> so that 50 gives me how much return >> totally it will become how much >> 58 to here everyone understood there also 50 will become 58 only here also 50 will become 58 but the magic starts now in That 58. Okay. In that 58, how much is the principle to be repaid?
>> Principal >> 50. Still how much is there?
>> Eight. In that eight again, how much interest I have to pay?
>> STILL HOW MUCH IS BALANCE LEFT? Who will take that four?
>> Equity will take already equity is getting how much their money how much you got. Additional additional.
This is possible only if the company is having debt. Debt works as a gear in a company that the thrust will be given by debt. 58 suddenly became how much? 64.
This concept we call as the financial leverage. Everyone understood the concept here. This lever will be given by equity at data. Lovely.
>> Companies having financial leverage means what I said this company is having financial leverage. What does it mean? That company is having debt. This company don't have financial leverage means what that company don't have debt. That's why all equity companies another name is unleed companies. What is the name?
>> Unle company >> and no g cycle.
Okay. Companies having both debt and equity are called as levered companies.
Called as what company >> means what is there?
>> Gears are there. Who are who is the gab here? That is a care.
So first understood the concept of financial leverage. Everyone students in life also please give an answer. Have you all understood the point? Sir here those who are sitting offline are you all having full clarity on financial leverage. Which companies will have benefit?
All equity are debt and equity are equity.
>> That's all. Debt and equities will have more benefit. Now what is the concept we are reading?
Huh?
Therefore we said advantage with no additional effort. Correct? Now answer which vehicle is more subjected to accidents car or a normal cycle? A person going on cycle is more subjected to accidents in India or persons in car are more subjected. A bike cycle you take person on a cycle person on a bike always you will hear who is getting more attacked by accident because what is there gears are there. So you saw only the side of advantage for gears there is a disadvantage also.
Do you understand my point?
That's called as a risk. That concept in the chapter we call as a finance risk.
Now you saw finance leverage.
It is not always good. Whenever there is a good on one side of the coin, there will be also a bad on other side. That's what we are going to analyze in this particular chapter. Good and bad of uh what to say this debt is the subject matter of discussion in this entire chapter. Everyone understood the logic clearly? Yeah. See I can tell you one point. Listen, listen, listen. Same example you take, I will change the facts. You will tell the answer. Tell me, shall we? First company, what is the only funding?
Loudly.
>> How much I have taken?
>> How much I have taken?
>> Invested at what rate?
>> I expected that it will give 16.
It gave me six.
We expect 16 and we will invest in something.
Are you listening sir? 16% is guaranteed return uncertain in the world who will give 16% guaranteed return then everyone will put their money there only guaranteed return risk-free return 5 6% it will be so tell me start again you are all equity how much I have taken from you >> 50 invest rate what rate >> but actually given how much >> answer sir >> 50 into 6% Answer sir.
>> I expected 50 to become 58 but 50 has become only how much?
>> Loudly.
>> This is the situation of which company?
Company one. Company one. Come to company two. Now uh come to company two. Now company two only equity data debt and equity.
>> How much I have taken from equity?
>> 50. 50 expected to invest in >> but actually gave me >> son I expected 8 rupees return but I got only how much >> so 50 became how much >> loudly >> now come to the debt side debt I have taken at what rate >> how much amount >> how much amount >> 50 I have taken how much amount >> 50 I have taken at what rate >> so I should pay them return of how much >> I should pay them how much return?
>> Four. So I have to give that 50 back. I have to give that four rupees also back sir. Yeah tell me I expected to invest at what rate?
>> How much was actually invest at what rate? So my 50 became how much?
>> But I have to pay how much to debt?
>> 54.
>> How much depit?
>> Equity have to bear that loss. My 54 became 53 because of you now. Sorry. H 53 become 52. Now tell me equity is subjected to more risk or not. So one side we have seen the good side of a leverage. Another side there is also bad about it. In this chapter they will ask questions on both. Sometimes they ask question on leverage. Sometimes they ask question on risk also.
Are you listening that on this? We are going to read this particular chapter up to here. Everyone understood the concept clearly. Okay.
Forget about all other things. I will just show you one document. Try to read that only. Nothing great required.
Read this. Let me make it full screen.
Take a minute time. Read it properly.
When I give you time, please spend some time. You will definitely get good inputs.
Have you read?
Have you read or not? Sorry, I will ask one simple question. Try answering this.
EPS belongs to whom?
Very good answer. Perfect. EPS belongs to whom?
>> Lou.
In our previous example, first example where there is a leverage 16% we invested now normally equity got how much 58 answer 58 or extra how much they got eight from debt also how much they have got and that will be added to what EPS that's what I have written Okay, don't read operating leverage because I did not discuss. Try reading combined leverage.
Just read and understand.
Even if you do not understand, no problem. I will anyway explain. Just try reading once.
Okay. See yesterday one one minute 1 minute please please please request yesterday we have done one question of PV ratio all those I have another question with me just see this as a question and answer see what I asked what are the questions I tested there please see there on the right side prepare second one third one >> B or B and break even point amount of break even sales anything hey I told both the formula for units I said total volume also I said you the answer you remember next after that finally see this illustration also don't write anything just see understand will complete hey tell me what is the meaning of PV ratio what is the meaning of P don't tell full forms when I ask you the question it will really irritate me when I ask you concept if you tell full forms What is the meaning of PV ratio?
What is the meaning of P? Simple question here. Yesterday I discussed that five times if you remember see don't tell words tell as a statement leverages financial debts and tax percentage change three like that if it will be any meaning or sentence or statement of nothing leverage debt tax 3%.
What is the way of answering bits and pieces and I should attach all those and prepare a screen play. Now your Rajim you will give all bits and pieces throw on my face like Christopher Nan I should do all the bits and pieces will be attached.
I asked simple question. What do you mean by PV ratio? Simple question.
70% right.
Uh yes, correct.
Repeat the statement loudly.
I said loudly.
Influenced by change tail unit to the right word volume. So what amount of profit is influenced by volumes is called as PV ratio. PV ratio will always say about what amount of your total profit is influenced only by volumes means if volume changes this will change from there onwards fixed cost will enter into the income statement listening and whether volume influence is there or not this will create nonsense in the income statement which one fixed cost about that only we are going to discuss next that's why I'm giving you 5 minutes time I will scroll down this one after another every 30 seconds I will scroll Hold down. Read the concept carefully.
After that, no excuse for you.
Can I scroll down?
Are you reading the note? Then read. If the tab that means okay.
Did you observe the income statement?
Yesterday I have given some income statement what came in my mind at that time as an example. This is different.
Okay, next read this full analysis line line analysis institute did not give all these things in their textbooks. So read properly PV ratio what is a P profit V that's answer it's very when you expand that it's very clear profit influenced by volume is the PV if you tell that in the form of a ratio it become PV ratio H profit volume ratio. No, I have said price volume.
Yesterday I said price volume. If I say 100% wrong, I'm very sorry. I take my words back. It's not price, it's profit.
By mistake I might have written price.
I said price volume huh yesterday profit volume then 100% my mistake very sorry change it to profit Are you Okay.
Okay. Can we move on to the next one?
Okay. Read break even derivations. All these are not required at this moment. Mainly understand the concept. If you want derivation also we'll show you how the formula came.
So live students also ensure that you are participating after the video will be gone. Please don't suffer later.
Join live and complete it live.
Okay everyone yesterday we have done this just reiterating with second example it will be a refresher for you new numbers new concept shall we continue to the next one everyone formula derivation also there just read it how come that formula Hey yeah I have given you one formula for break even point fixed cost divided by PV ratio you have written yesterday how that formula came logic I told you derivation also given you can read contribution equal to fixed cost at BEP what is contribution contribution per unit into number of units that will be equal to fixed cost so number of units B is fixed cost by CP like that it was next B in rupees B units into sale BP units already formulated that fixed cost by CPU into SPU. So fixed cost into SPU by CPU. CPU by SPU is the PV ratio.
SPU by CPU will be 1x PV ratio. So fixed cost into 1x PV ratio makes fixed cost by PV ratio.
Basic mathematical equations here nothing great no rocket science.
Can I go to the margin of safety? Mark margin of safety very very important for exam. Don't suffer in examination hall.
I'm telling you number of times. There are around 10 exam questions where margin of safety is tested.
So please read the concept carefully. I will give extra 3 4 minutes time for margin of safety. Read it properly.
How to calculate operating leverage with margin of safety?
One by margin of safety. How to calculate marginal safety with operating leverage? Operating one is inverse to another. Margin of safety is inverse to operating leverage. So operating leverage is also inverse to margin of safety. Therefore 1x M is O. Od 1 by M S is O. 1x will be m Okay.
Can we move on to the next one?
Profit not required this. You can see along with the derivation. You can see operating leverage can be written as what?
Yesterday I told you that derivation also for this to you correct uh another way of derivation is also there. See there one by margin of margin of safety means what? Break even beyond break even.
Therefore total sales minus break even sales can be written as a margin of safety. Yeah. So numerator total sales minus break even sales divided by total sales. Listening. Multiply both numerator and denominator by PV ratio.
Multiply both numerator and denominator by what? Because PV ratio is something which affects sales break even sales and total sales everything. So into PV ratio divided by PV ratio both sides listening numerator denominator multiply by what?
>> PV ratio. So I can multiply like this sales into PV ratio. Break even sales into PV ratio divided sales into PV ratio. Tell me sales into PV ratio gives us it there sales into PV ratio will give contribution correct break even sales into PV ratio will give you fixed cost.
Yes or no? So contribution minus fixed cost by contribution. Contribution minus fixed cost is called as what? Profit.
Profit by contribution means EV by contribution.
Operating leverage formula.
Operating leverage formula contribution by EV here what we got EV by contribution. Therefore operating leverage is contribution by EV. So operating leverage can be written as one by margin of safety. This already we discussed in the last class in a simpler way.
If you remember with this we revised all the concepts finally touch to the chapter and then we will start with our question. See once the questions start in this chapter there is no stopping in the middle straight away we will do whatever the questions are possible for today and we will complete it clear but still another half an hour of my shouting is still pending what is the concept leverage I explained financial leverage I explained operating I did not and moreover I explained from the leverage point of view now we are going to see from the risk angle which is more frequently tested in exam than the leverage. What is the name of the chapter?
Name of the chapter answer.
>> But exam heavily tested is not leverage.
Heavily tested is what? Risk side of this chapter. So let us try to understand and complete the discussion.
Start reading the questions answers. See the screens.
See what is the name.
>> Risk. See very very interesting concept.
If any one of you sitting here wanted to explore finance side, take seminars, speak something on finance, this is the best topic because it is evergreen concept. Even after 100 years, this concept will work in a similar fashion.
There is no concept of this becoming outdated. So please listen carefully, understand it in a proper way. Okay.
Name of the concept is risk analysis.
Which one?
>> See the screen. half an hour, 45 minutes or 1 hour even it's not in my control it depends on you how you reply if you reply okay or else I will repeat start first one everyone repeat the income statement once sales will give you minus will give you minus >> interest will give you >> minus will give you minus will give you divided by will give you will give you EPS into payout ratio will give you DPS. H now listen listen.
This is our income statement.
Okay, for clarity sake I am first removing this part.
Let us put in the another page. Clarity will be there. See in our discussion to make it very simple to understand.
Let us assume that there are only two either equity or debt preference is not there.
Listening what is not there is not there. Let's take that assumption and start understanding preference comes now what will happen I will tell you once after this okay so see here first part number one so students in live also are you all ready please give a reply we are going to start with the final part of leverages chapter everyone here also please listen this is the final discussion of leverages 30 or 45 1 hour even I don't know let us first begin yeah start see here there is a company Concentration please everyone see the screen.
Shall we start risk?
There is a company year one and this year let us understand or year zero you take year zero this year sales 100 units into 10 rupees each 1,000.
Okay. Variable cost. Firstly tell me what is variable cost?
Cost which will vary is a right statement or wrong statement.
It's a half right half wrong. Yesterday I told you cost which vary means it will vary. Cost which vary with the sales is correct answer.
Yesterday also I said this point to you.
Cost which vary is not variable cost.
Cost which vary along with the volumes.
Cost which vary along with the sales will be always constant changes.
Sires >> sales will change along with 30,000. What is the sale price per unit?
>> Number of units if it is 200.
Oh need 200 into 10. Huh? Tell me what is the answer? 300. And the sales amount is changing because of what? Volumes.
Because of what? Volume of sale. Okay.
Now tell me sales is influenced by volume or not? Variable cost. Tell me I will manufacture 100 units means for 100 units I have to incur say for example 6 rupees expenses. Correct? Per unit. 6 rupees is the cost per unit. 6 rupees is the cost. Tell me how much is my cost?
600. What is my contribution? 100 units into four. Tell me how much. Very good.
Next one. Fixed cost influenced by volume uninfluenced by volume.
Let us say 200 is my fixed cost. Okay.
What is my EBIT?
Minus interest is influenced by volume uninfluenced by volume.
Let us say there is a 50 rupee interest.
Okay. Next EBT how much?
Answer example. Let us take tax for understanding sake. It will be simple for you to understand. Okay. Tell me what is the tax?
>> 15.
>> 15. Okay. I will remove 15. Tell me how much is my EAT?
This is the situation for this year up to here. Understood clearly? Yeah. Next.
Let us continue further. Year 1. Year one you tell I will write. Year 1 sales increased by 10%.
Sales >> increased.
>> Tell me what is the sale price now?
Sale price per unit is how much now?
Loudly participate. Everyone said next year how much it increase? How much it will become? Loudly. Wrong. When I say sale increase, volume increase not the sale price.
So don't add to the price, add to the volumes.
Everyone don't add to sale price, add to the sale volume. So adding to price is wrong. That's what I wanted to tell.
Okay. When I say 10% sale increase, I'm telling 10% sales volume increase, not sale price increase.
Clear? Tell me how much is the volume previously?
100 raised by 10% means it will become how much? Variable. Uh first let us write sales. Tell me 100 110 110 into how much total it will become how much? 1,000 up to here everyone understood?
Variable cost will be same 600 cost also will increase tell me how much it will become 110 into 6 660 it will become correct next after this tell me what is the contribution how much it will be very after that give the answer interest EBT sir EBIT sorry Fixed cost sorry fixed cost >> EBIT interest >> EBT tax >> how much 90 so totally >> 170 up to here everyone understood now the discussion starts please answer to the question clearly let us take sales contri sorry sorry variable cost contribution Year zero, year 1. Tell me separately what is the sale here? What is the sale? Here what is the variable cost here? What is the variable cost?
>> Here what is the contribution here? What is the contribution? Now you will tell the answer. I will listen to your answer. Increase decrease over year.
>> No change. We are going to prune. There is no change at all. Volumes the whatever is linked won't change every year. It will be same. 000 see there you are seeing numbers I'm seeing percentages see what is my PV ratio in the first year what is the formula for PV ratio contribution by what is the contribution David don't use calculator for those things at least second thing if you use I will understand 400 by,000 into 100 tell me 40 next one you use calculator 440 by 1100 into Answer sir, where is the rise in profit?
Where is the rise in profit?
There is no change. So now you tell me even though sales is changing. When I say sales, what is the change? Volume change happen PV ratio will change or will not change.
You asked me one question yesterday.
What is the significance of PV ratio?
There significance of PV ratio. PV ratio is some great thing in our income statement which will change along with the sales which happens to be constant over years.
Are you understanding? Yeah. Sales drop.
PV ratio will be maintained because corresponding variable cost also will drop.
Do you understand my point clearly?
Yeah. Sales are dropping. Corresponding what also will drop?
>> Cost also will drop. Which cost will drop? Therefore, PV ratio will always stay constant. PV ratio is not variable.
Those sales and sales and variable cost are variable. What is the greatness of PV ratio? PV ratio is a great invention of some person where sales is variable fixed.
We sales variable fixed variable cost PV ratio fixed. It's a constant.
Those two things are standing variable.
V always stands constant.
Listening.
Try to understand. Sales reduced by 10%.
Let us say increased or reduced.
1,000 will become 1,000 will become sorry roughly I will write 900. Variable cost will become 540. This will become >> 360 by 900 into 100.
again 40 again 40 correct changing and not changing that's why in all cost analysis costing increase the PV factor because the PV ratio will always tell and discuss about a constant number 40% is always constant sales increase of sales decrease or whatever may happen P ratio is always constant. First of all, discussion number one. Everyone understood the behavior of P ratio.
>> Where you will learn all these things sir costing you have to learn in margin costing. But I always have a habit if I teach one subject other subjects if we touch I will go very deep into those also and I will cover here itself irrespect of what they will do in that subject. So the main discussion is PV factor is a king of income statement because though it is influenced by two variable factors, it is not a variable.
Here everyone the significance of P factor P factor will always say about some constant number though it is influenced by two different variables not a completed we just started now answer sales variable cost PV ratio please answer what is the percentage change no change sales change no Answer >> change.
>> Though the sales are changing, PV ratio is changing. Not changing.
>> Not changing.
>> And what is the importance of PV ratio?
Now tell me what is the PV ratio? PV ratio is a profit. Huh?
>> Hey, PV ratio is a loss number of profit number. PV ratio is a loss number of profit number. Profit number which is influenced by volume. uninfluenced by volume su which is influenced by volume.
Uninfluenced by volume s influenced by volumes but still it will stay as a constant number. Clear because it changes along with the volume. It will always remain constant. I should have clearly listen.
This is the complexity of this chapter.
If you do not listen, you will lose great deal of concepts also in exam hall. Listen now.
See first three parts of the income statement analysis understood clearly.
What are the three elements of income statement? First three sales, variable cost, contribution. Three parts we completed fully. There is no other part to discuss in this. Can I move downwards? Now slowly we are coming downwards. Then enter the villain who is at fixed cost influenced by volume.
Uninfluenced by volume those who are fixed will make profits variable. Those who are variable will make the profits fixed. So don't think changing persons are dangerous. Those who are sitting idle are more dangerous.
Are you understanding the point? Very very dangerous.
So in this also you see I will ask a question. Try answering this.
My profit when I say profit I'm talking contribution profit. My contribution profit is how much last year?
Louly.
Very good. What is my fixed cost?
What is my operating profit?
Can I expect a proper answer from everyone? Start again. What is my contribution profit?
What is my fixed cost? What is my operating profit?
Louly.
Very good. Now you answer to the question next year. Sales bumped by how much%.
Lovely.
Super. So contribution is how much?
For increased contribution, there is a increased fixed cost. Same fixed cost.
My profit is how much?
Loudly.
>> 240.
>> That's the question I'm going to ask.
What is the percentage change in sales?
You should not get that doubt. Already I said that four times. Tell me what the percentage change in sales.
Very good. Take calculator. Take calculator. Tell me one answer. What is the EBIT last year?
Now how much? So 240 - 200 whole divided by 200 into 100 answer now tell me hey can't sorry sales change by how much% now I will ask two questions I should not present a wrong answer minute of the second law first apply your brain and tell the answer okay start what is the percentage change in sales what is the percentage change in variable cost.
What is the percentage change in sales?
What is the percentage change in variable cost? What is the percentage change in contribution?
What is the percentage change in fixed cost?
If you get a doubt for this question, start again.
Start again. What is the percentage change in sales?
Percentage change in variable cost, percentage change in contribution, percentage change in fixed cost, >> 0% no change. What is the percentage change in EBIT?
Answer, how much change in sale?
How much change in EBIT?
>> That's all. Gear started first gear is fixed cost.
Gear number one in a company is now I ask a question. This fixed cost is because of interest because of fixed cost in the product.
Apply this. I said no brainer. Apply this and tell the answer properly. Shall I answer? Fixed cost. You're writing. And the fixed cost. WHAT KIND OF FIXED cost it is?
that fixed cost interest cost or operating fixed cost tell me bank loan is taken interest is paid which cost bank one lakh loan is taken 10% rate of interest every year how much I should pay amount so 1 lakh into 10% take descended what is the loan taken rate how much interest every year sales increase how much interest I should pay sales fall completely zero after flaw project irrespective of anything what I should pay 10,000 fixed cost I should pay that fixed cost is 200 salary wages that linked to operations linked to financely.
>> Uh now tell me EBIT above what is there?
EBIT above what is there? That is operating fixed cost. Financing fixed cost.
>> Very good. Which is which cost?
It is the gear number in the company cost. These two are the two powerful G in company. Sometimes they are can be used for good. Sometimes they only will become villains in the company. How it will be? Let us understand. First story line is the hero. Second story line will be the villain. Now we are discussing about the hero.
See, see there.
So, EBIT increased by how much%.
>> Answer. Now, I will ask one small KY question. Answer this. Hey, listen. What is the percentage change in sales?
What? EBIT grown by EBIT grown by how many times EBIT is to the sales that's operating leverage formula percentage change in EBIT by percentage change in sales 20 divided by 10 times you understand the discussion I told you one point the other day last yesterday last five minutes of the class when we will use that percentage formula that's 2 years is given here.
Do you understand?
Do you understand? Sometimes not always some mainly we will use when two years data is given. Even if two years data is not given also we can use that formula when we will use in the exam questions I will show you. Okay. So now start again please patiently answer up to variable up to contribution. I'm not going to discuss again. I hope everyone understood that point clearly. Sales is variable of fixed time. Variable cost >> contribution PV ratio >> PV ratio contribution is variable but PV ratio is fixed number up to their clarity >> below what is there >> change won't change.
>> Therefore EBIT change and sales change will be same will be different >> answer.
Sales grown by >> but EBIT grown by 20%. Means influence is how many times?
>> Two times it's a magnified impact is okay. Now we got which one? EB. Okay.
Now I will ask you third part year number one the alternative one is alternative two. Alternative to story let us change screenplay little bit.
There is a fall in the sales instead of rise in the sales.
There is a fall in the sales instead of in the sales means 10% raise at 10% fallus 10% plus 10%.
Please fastly give the answer. 100 units will become into totally next 100 units will become into become 100 will become into how much it will be up to here. I think there is no doubt to anyone. Percentage is how much again contribution to sales percentage 40.
Contribution to sales I ask PV ratio 40.
First case, second case, >> third case.
>> Though numbers are variable, percentage is always constant. That is the significance of dash.
>> Next.
Next one. Fixed cost will change will not change. How much is the fixed cost?
>> Okay. Now what is the EBIT?
200 became 160.
200 became.
>> Take calculator. 160 - 200 whole divided by 200 into 100 how much it is in plus 20 now it is how much means that's what I told you at the beginning of this class this leverages hey listen in the first example the first example means year one here there is a leverage and there is a risk >> confidently you give wrong answer not again I'm asking you simple question in previous last discussion 10% sales have grown but EB grown by is advantage and disadvantage advantage now see 10% fall in the sales but EB did not drop by 10% e drop by how much percent and here there is a leverage risk these are the two angles of understanding this chapter one side advantage we have feel another side risk also be see when sales are raising when what is raising >> sales at a sale price the sale volume answer volume increases it will become leverage volume decreases it will become a risk become a means fixed cost is neither a hero nor a villain repeat what I said fixed cost is neither a hero nor a villain it will become hero because of increase in volume it will become villain in because of drop in the volume and who is the main center of attraction villainer volume that's why the name of the chapter in CMA is cost volume profit ratio CMA books perfectly they use that because they are most into the cost you understanding huh they use that language properly cost to volume profit analysis means cost and profit are influenced by the middle thing called as volumes do you understand the point clearly here. So tell me now volume increase will make fixed cost a hero. Volume decrease will make fixed cost a villain.
Understood the point clearly? Yeah. So who is the more intimidating villain for this particular chapter? Volume say volume change everything will change.
Example guy will ask see the screen tell me first year what is the sale units?
Answer 100. Variable cost 100 into something contribution also 100 into something correct answer cost how much EB how much one year change volume did not change 100 again tell me >> again how much is the sale >> 1,000 how much is the variable cost >> how much is the contribution how much is the fixed cost is EBIT change no change why there is no change volume did not change that's the point I wanted to They answer who is the villain here? Are you a villain? That's why always the management tries to sell more in volumes.
Understood the point of more sales should happen. This is a basic science in every finance as a CFO to the company what you will advise you should understand the nature of your company.
You should give a proper advice to the management when you will give if you have knowledge on the reason that's the reason why you will do CMA you are doing all the what you doing all these things you should work like a labor again in normal company think something differently why we have to do these courses we should be giving advices to management means you should first understand business you should understand how it operates then you should give an advice how the volumes are affecting your Logically speaking, first, second, third, everyone understood. Year zero, first case, second case understood everyone up to what we discussed. Now, EBIT till we discussed. Okay. To sum up everything, just answer to the question.
See, first case, the second case, you see first case was sales. How many units? It became how much? Okay. It became how much here? Who is the villain?
Volume. Okay. Here. Who is the villain?
Fixed cost. Why fixed cost became a villain? Because volume changes. Huh?
Here it is a hero. I'm very sorry. First case it is a hero. Why? Volume changes.
Increase or decrease.
>> Here volume has increased or decreased.
Therefore, this became a venom. It became only 160. Here 20% raise 20% fall. But one thing is clear 20% is common.
What is common?
>> Therefore leverages once calculated it's a common for that company till you change your fixed cost.
You listening you change your fixed cost again leverage analysis also will change for that cost structure. This will be the leverage question for you. Fixed cost return there is what? Fixed cost.
Financing fixed cost operating fixed cost.
It will come in the form of what?
Examples of operating fixed cost.
Is an operating fixed cost. Salary is an operating fixed cost. Wages to the factory. A workers is operating fixed cost. If you pay on a monthly basis, hourly rate if you pay that's different again.
Okay. If you pay fixed generally in India they paying only fixed factory salary to employees how they will pay every month 30 or 40 1 something fixed salary all those will come under that FC operating fixed cost up to here if you have clarity we'll continue shall we up to EBIT understood everyone now you please answer why EBIT changes why EB Don't come directly to volume just because I said that why EBT changes because contribution changes.
Repeat again why EBIT changes >> loudly changes.
>> I will ask one question. Fixed cost will change or will not change.
>> And if contribution does not change, EBIT will change will not change.
Contribution does not change. EBIT will change will not change. answer will not change >> that's why one of the formula for operating leverage is contribution by EV two formulas I said two formulas analysis I'm trying to explain why the formula came like that EBIT won't change if what won't change EBIT change if what change one way contribution by EBIT why contribution is changing >> sales changes if you want to tell that same in percentage Percentage change in EBIT by percentage change in sales.
Clear everyone.
Why EBIT changes? Because contribution changes. Why contribution changes?
Because sales volume changes. What changes sir?
>> Sales volume changes. Okay. Up to here understood everyone.
>> 200 240 160 everyone full clarity. Yeah.
Let's come to the downward part. Next 10 minutes we'll complete this discussion and then we'll go to problems. Okay. But have clarity up to EBIT up to >> and up to what?
>> Up to what? 160 240 200 up to that if I draw one line imagine that I am drawing a line. See like this.
See up to here if I draw a line anything above this now. Okay. Uh anything above this from 160 200 360 540 900 240 200 440 660 1100 200 200 400 600,000 all these anything above this red line we call this part as operating leverage or operating risk.
You can tell in both the ways when there is a increase in volume we call it When there is a decrease in volume we call it everyone understood the meaning clearly. Yeah. And this is influenced by your financing. Yeah. Uninfluenced by financing.
I will ask a question. Answer if these questions will come perpetually perennially. Answer.
I am financing by equity. I am >> uh I'll ask one question. Try answering.
For example, I wanted to buy see this pen marker.
Okay, I wanted to buy this marker. You will go to some stationary shop. You will ask him how much is this? So 100, 150 or I don't know exactly some some 100 or 150 something. He will tell you.
You will see three brands.
Okay, I don't know what brands because I never used this in my lab.
So some X Y Z three brands are there. I heard that brand Y is very good. Three pens are kept in the shelf. Brand X, brand Y and brand Z. I saw and I asked give me brand Y. He gave me he said 300 rupees. I paid 300 and taken.
My choice of taking brand Y marker is what?
Why I have taken? What is the purpose?
What is the reason why I have taken XY Z? I can take X or Z. Why you have taken Y? Quality is good. What I heard reviews are very good for that marker. It will be longlasting than the normal marker.
Are you understanding that? Generally, these are the things which will affect our purchase. Correct. There is another pen flow will be super longlasting and longevity will be very less. Those who want more flow when they write on the boat will go for that particular market.
longlastingness and longevity. If you require it go to Y.
Okay. When you hold it, it will be very much good and other things are there in brand Z, people will go to the Z.
These are the factors which will affect the sales of a product. Correct?
Now you tell me how many of you till now in your life went to a shop to buy something and as the shopkeeper you are purchasing these out of your own money loan money how many of you asked on that basis I have you purchase means for example she is the one who is selling the pen I went to her I asked please give me the pen that particular marker X or Y or said isn't I she will give me I will pay the 200 or 300 she will give me the pen over transaction completed instead how many of you done like this I will go to her and say you open this shop with your own money or loan money if it is own money I will take that pen if it is loan I will not take is it needed of her how she financed her purchases is it anyway link to our sales answer everyone And you will go to a shop and first ask the shopkeeper how you purchased everything here out of loa stealing or theft. We will ask all these questions.
We will ask about product. Yes or no?
What is the point I wanted to tell?
Sales is never influenced by the mode of financing.
I said >> sales is never influenced by your mode of finance. You finance by equity, you finance by debt. Who care? People want the product quality. That's all. They don't ask you financing mode the point clearly. Yeah. Same thing I wanted to emphasize. Please listen carefully.
So sales available cost contribution fixed cost influenced by finance.
Uninfluenced by finan operations influenced by oper your main business will influence the TV not the financing modes up to your clarity.
Yeah. Second, last and final downward part we are going to now see here you are financing your capital not by equity both by equity as well as debt both by see the screen and tell first the case what is the interest >> see there and tell >> second >> third what you understand fixed cost is changing not changing First case, what is the sale? When I say a sale, I'm talking about units. How much is your sale? Units >> at the time, what is my interest?
>> Second case, what is my sale?
>> At the time, what is my interest?
>> Increase that increased constant.
>> And if I make extra sale, they will ask extra interest. No extra interest. Super fantastic. Next case, third year, I mean uh third case. How much is my unit?
Interest is reduced. They increase the constant with the fall in sales will they compromise the interest won't compromise again interest is a villain interest also is a fixed cost like the salaries wages etc but interest is which kind of fixed cost operations fixed cost financing fixed cost that's why interest again is a hero if volume increase is a villain Hon will ask a question you all people whether you use calculator don't use but give a proper answer okay tell me what is the change in EBIT over year 0 to year 1 alternative one what is the change in EBIT I'm talking change means always sell in percentage 200 became 240 means how much change we have done already we become 240 means how much change 20 rupees are 20% less or minus keep it forget about the third case first second you compare first what is the percentage change in sales answer what is the percentage change in EBIT huh very good next EBT how much eBT became how Very good. Now tell me EBT 150 became how much?
150 became how much?
>> 150.
>> Okay. Tell the change 150 190 minus 150 whole divided by 150 into 100. Closing minus opening divided by opening into 100. Yeah. Nothing great.
26 points.
>> There some main story. Now tell me sales increased by how much? Probably super eBrees by how much sir?
EB EB increased by how much sir what you understand now interest has become a hero now hero again it helped us a lot because that's a leverage again gearing is created again second gear was given increased the speed of profits so 20% evit profit has suddenly become how much 26.67% 6 7%.
Same will also get repeated on a negative side also or not. If the sales are dropping if sales drop EBIT fell by sales drop by 10%, EBIT drop by answer now 200 sorry uh 150 became here 50 will be written again.
The year again 50 will be written. Ah.
Okay. Now tell the answer everyone.
Uniformly tell the answer 50. We have to reduce. How much? It will be 110. Tax will be how much? 11. How much? It will be >> 99. Tell about this 150 became 110. Take the calculator 110 minus 150 whole divided by 150 into 100.
>> Same C is 26.6 minus can become 46. So minus how much?
26 >> 26.
>> Okay. Common sense. Let us use common sense if any.
What is this?
>> 150 190 110.
>> Huh?
>> Very good. What is the below tax? Tax is fixed or variable?
>> Loudly. Super. If tax is variable, EA will be startable fixed. Hey, EBT is variable or fixed >> variable. It will change 150 190 190 means it's changing or not. See interest is fixed. Fixed cost is fixed. Remaining all are variable.
Sales sales variable cost contribution.
So change in sales, change in variable, change in contribution will be same or different.
You're not answering. Start again.
Sound is going brain crossing is very slow. I problem. Start again.
Change in sales, change in contribution will be same different.
>> Huh? Change in variable cost, change in sales.
Answer. So tell me sales, variable cost, contribution, rate of changes, same are different because all are if everything is variable down the line, you need not compute each and every time separately.
First one change, second one change, third one change, same. Now you answer with common sense. EB is EBT is >> EB is tax is tax is >> EAT is EPS is therefore if you calculate the finance leverage percentage change in EPS by percentage change in EBIT they will do because you can do percentage change in EBT by percentage change in EBIT also same answer will come because down the line everything is variables only you understood what I said tell me the second formula for financial leverage percentage change in EBS by percent change in EBIT The doubt should come I should do percent change in EB you do same answer will come because from there everything is a variable if you earn 100 rupees I will take 10 rupee tax if you earn 200 rupees I will collect 200 rupee tax is a variable number of fixed number across any income I will collect 100 rupee like the government won't tell sales increase tax increase tax If it fall tax also will fall variable or fixed variable.
We understood the point clearly. Answer final discussion. Yeah. Tell me. Okay.
Answer.
See.
Eat changes. I will not repeat this one more time. Listen one time. Eat changes because EBT changes.
Repeat the shape.
>> EAT changes because >> EB changes because EBIT changes. Repeat >> changes because changes.
>> EBIT changes because contribution changes.
>> EI changes because >> Contribution changes because sales changes.
because >> if sales change yet is changing or not EPS will change or not combined leverage percentage change in EPS by percentage change in sales understanding the point clearly yeah who is the main villain in the entire cost in the entire income statement volumes are the villain so you maintain proper volumes in your company risk will be reduced to zero level almost that's why companies will spend that much amount on advertising their products. They are not damn bloody fools to do those. They know this financial leverage concept. That's why they always moderate on that. They spend cr of rupees on advertisements.
Why? If your volumes are affected in a negative way, you are gone.
Understood the point. See, tell me my volume is changing, decreasing. My company is at a risk. Not at a risk.
answer not at a race if you don't have fixed cost what I said don't have fixed car here problem IS NOT ABOUT FALLING VOLUMES also always even if volumes fall for example my company fixed car not there in not there remove both of them and see remove what tell sales sales Yes, >> read there. Sales >> variable cost >> contribution fixed cost >> fixed 200 >> I said remove fixed cost fixed cost >> what is my EBT >> second year okay second case sales increase sales >> increase >> increase tell me how much it will become >> where will cost >> contribution fix >> how much is PV8 >> 4.
>> Now growth is how much?
400 became 440. How much?
>> 400 became 440. What is the rate of growth? What is the change in sales?
>> The change in EBIT both are same costs are not there.
Third case you see 100,000 became 600 became 400 became >> fixer cost >> then this will also become >> 400 became 360 means what is the percentage of fall >> answer sales fall by >> where will cost fall by contribution fall by eB also fall by what you understand If EBIT is not changing, I mean percentage change in EBIT is not changing. If what is not there?
What is a complete full analysis of all this discussion? You should give advices to the management keeping in view what fixed cost that company is employing.
Are you understanding what fixed cost that company is employing? Answer my day. As a cost accountant, as a chartered accountant, what adise you have to give to the company? If that company is having more and more fixed cost into its cost structure and financial structure, you should tell the management now okay sales are very well.
But if the sales drop I will can I give you one example? See here I started a CA institute physical institute opened branches everywhere in the city suddenly students reduced. What will happen?
Huge fixed cost. Can I operate I cannot operate? Close all the branches.
That's what you do.
Hey, understood the point clearly. Yeah.
That's why when fixed costs are more don't over action.
Understanding. So if fixed costs are heavily loaded now, you should not do over action in your business. You should be down to earth. So if you do over action, you will only close the branches.
Yeah, understood everyone.
So what could be the possible reason?
Reason is very simple. When loaded fixed costs are coming now so many branches will be there. What will happen?
Students will reduce all of sudden. It will take one attempt to change everything. Now so students will suddenly fall. It will be drop. Once a drop is there for that sudden drop in the number of students. Are you listening?
Your fixed cost won't stop. Suddenly you have to close everything or you have to incur lot of fixed cost and enter into losses.
That's a danger always. We can see so many examples around us. If you can't understand finance properly, no one will change you to understand how the businesses are working in India understanding or not. So that's a simple logic of finance. See answer my question listen my company is having fixed cost. Danger not a danger fixed cause if you have danger not a danger if I have fixed it's a danger not a danger everyone >> tell me I have fixed cost but there is no volume change risk and no riska answer I have fixed cost and volume the changes are coming on downward side riska no riska Okay. It is a risk up to here.
Understood? Uh if I have there is a drop in the volumes, there is a drop in the volumes but I don't have pixel cost. I am at a risk not at a risk. There's so many examples we saw. Now you should observe one point. T there is a institute in + one and + 2 + 1 and + 2 + 1 + 2 in is there first standard to 10th standard one school is there 1 to 10 L to 10th one school is there plus one plus two school is there CA one college is I mean institute is there let Just name them A, B, C. Listen now. A B C. All the three are having their own students base.
Answer. All the three are having their own students base. Good students base is there for all the three. Now listen, there is a fall in number of students.
Okay? There is a market fall is there.
Market downward trend is there in education sector. Let us say for example it will affect will not affect it will not affect the first and second category because they are in essential commodities.
First you should understand as well why sales are dropping. This is what I said a charted accountant should analyze from line to line point on point we should analyze because you are a charted accountant. You are not a become degree holder to give whatever answer you want.
T the main analysis of leverage chapter is as why sales volumes are changing. See at the end what we discuss villain is volume correct answer I want to control that first you should understand what business your company is in. My company is in discretionary business. Everyone repeat my company is in what business sir. Can you please explain what do you mean by discretionary business? Discretion means option you may buy may not hey 99% of urban population in India not even 99 almost 100 educated educated literate illiterate s means at least from 1 to 10 they will study and that will become compulsory it essential item or optional item answer when something is compulsory even market downward trend won't affect that business at that time you have whatever fixed cost you want no problem you listening because volume fall will not be there so often industry danger instituted danger you understand the point how can you put so much money in lot branches and operate that's why first when this institute was started my first advice is don't start branch unless and until real need is there if need is not They accommodate as many students as possible only in one branch.
It's a wrong financing decision if you open lot many branches because we don't know when this industry will fall.
Are you understanding now? It should run on a foundation of basic financing principles. You should not take heavy risk and start branches elsewhere. Now problem is I will tell you this industry is a volatile industry means it will not be fixed always. Right? This atom 300 students will come next,000 will come.
Next time 2,000 will come. Suddenly it can also fall to 200.
We can't do anything.
At that time who will pay all those fixed expenses?
Do you understand the problem? Huh? Why?
Go by variable cost. Always go by really thousand students came all of sudden take an auditorium for that batch. Take him close it. Answer is over. That's it.
Over. Don't start a fixed branch because student will come only once for this industry but school 10 times he will come for 10 years you have taken in coaching over you will go again you will come to CA and coaching that mean here industry has no repetition these are all basic financing principles now when you operate the CA in this institute so repetition of course attempts may be there student may write multiple attempts but student won't come multiple times to the same institute.
See basic principle we know in which academy he failed he won't go again I'm telling the truth better truth in this industry and he mentally fix that there only I fail I should not go back again and repetition also not there that's the problem of this industry you should understand all these and suggest a correct financing idea to an academy I always suggest only one thing if buildings are your own you do whatever circus you Huh?
Are you listening? I have one buildings here. I have two buildings. All the two buildings are my own. You do whatever circus you want. Spend whatever money you want on advertisements and other things. But if they are not your own buildings, if they are rented premises, be very very very careful because this industry is a danger in its volumes.
Last and final example we will close and start with the questions.
Covid time 2020 2021 almost up to 22.
Do you know automo segment has fallen to almost near to zero. Reason there is no uh public direct contact social distancing is there.
If you close the door another person you are you will be having inches gap which will be very very dangerous. Government has said that complete ban on travel.
Who will be first affected? Automoils.
Reason is no one will buy the car. When will I buy the car? I should have a possibility to drive outside. Then I will buy a new car.
One full year almost everyone is sitting at home. Which will buy cars? Second home industry. Construction business.
Okay. Construction business is the second dangerous industry during the covid time because construction business workers are required one or two hundreds big projects thousands also required correct. So what is the problem when thousands of workers are required if social distancing is there who will come? So there is a problem in the labor in home industry there is a problem with the mindset in automobile segment that's why you know or not mari has lost its major market during covid time at that time hyundai and Toyota has captured the market why people stopped buying morti cars I mean mi sujuki cars market share before covid for mi is 53% in India Postcoid it came to 37%.
See the downfall for Sujiki I mean Sujiki company Tata during that particular period they have done immense research on electric segment they got time 2021 or 2122 after only Tata has like anything and what they might have done during that time they got a huge time to bounce back into electric segment then what Mari is not doing they have done that at that time segmental changes they brought tails pushed up like anything 2025 highest to sold cars are from Tata how that's the main business these are all the subjects which you have to apply in a real life way now answer automo segment is essential discretionary answer >> people will buy only when there is money with them correct >> now you answer I will give four or five items you try to understand them toothpaste uh what to say uh shampoos soaps etc. These three are essential option law came let me brush after one year like that no one will recision is there in the market let me bath after one year mean because of another new disease will come correct everyone and what is the point logic here because of any calamity like etc automobile business is affected construction business is affected Hindustan uni labor raised its prices raised it sales during During that time because a new segment sales started for them called as people started buying liters and liters.
Spray everywhere drink if possible. So people started using that and till then no one used to buy hand sanitizers at that time. Yeah. People started buying like anything bottles small tetra packs came small packets came. India is a land of creativity. Big size became small size. Keep it in your pocket and go like that. There is a lot of invention that happened. It became an essential item for 2 years almost.
From all this discussion what you understand. Hindustan univer can have whatever fixer cost they want. No problem because their goods are essential. Hindustan uni liver is selling all life ready items. Means every day you will use the products manufactured by Hindustan univer.
But the same is not the case of automobile segment. So now everyone confirm one thing which companies can afford more fixed cost.
Which companies can afford more fixed cost?
Companies in essential commodity can afford more fixed cost because generally there will be no drop in sales to a high extent.
Which companies cannot afford more fixed cost? CA industry in a classic example.
It's a thumbnail rule. Do you know what is the rule? If you are into CA industry, avoid as much fixed cost as possible.
That's why staffing also here is very very limited. Two people will work because fixed cost because 2 months the exam time academy will be stopped completely. I mean it will not run with the profits. At the time also what we should pay at that time also we should pay the salaries or not.
So better avoid as much fixed cost as possible. Listening rent is a fixed cost. These are all fixed expenses essential commodity. Now you do whatever circus you want but ours is a discretionary commodity. You should not do over action in this business if you want to make profits.
Clear with this we are stopping with our discussion on concept of leverages. I hope everyone of you understood entire segment of leverage concept from sales till EPS. You understood the concept.
Everyone can I believe that? Tell the income statement format clearly.
Everyone start >> sales minus variable cost contribution.
uh that divided by number of shares will give you EPS into payout ratio will give you DPS. So DPS changes because EPS changes. EPS changes because EAS changes. EAS changes because EAT changes. EAT changes because EB changes.
EB changes because EBIT changes. EVAT changes because contribution change.
Contribution changes because sales changes. Sales changes because sales volume changes. Sales volume change because you are not into essential commodity.
Understood the point.
Something invisible is really the risk.
What is the real risk? The nature of your business. The nature of your >> The nature of your business.
>> Which businesses are more subjected to risk? Discretionary or essential?
>> Loudly.
>> Discretionary. That's why operating risk another name is business risk.
You tell that this discussion till now.
What is another name for operating risk?
Why they call business risk? Because from the nature of business the risk is coming. That's why see my entire discussion for the last 1 hour is only for one thing operating risky. Another name is what? Why if a person ask this is all the explanation for the last one hour.
Now last and final discussion before we close tell me finance risk comes with the business risk even without business risk.
Finance risk will be below EBIT above EBA that will come with the business risk irrespect of business it will come only when there is business arrest no business risk no finance arrest no business risk means no EBIT change if EBIT do not change EB won't change EAT won't change EPS won't change means EPS is changing because of EBIT EBT EPS changes because >> EAT changes because >> EB changes Because EB changes because sales contribution and sales as EB did not change means below items won't change you know what is the meaning source risk is what risk business risk so your main way of business is the danger here if you are into essential commodity business you do whatever you want anyway sales will not change at your home you just think of This particular point in the way in which I say if you buy a toothpaste it will come for one month let us say at home suddenly 5 days paste will be completed at any month unless and until there are festivals or relatives came or huge population coming in and out okay normally you are four people at home tell about any normal traditional month you are four people living at home one toothpaste will come for one month every month you will buy groceries You will see your parents every 1 month or two months they will go to supermarket and they will buy whatever grocery is required for the next one month or two months correct almost every month plus or minus 500 rupees the bill will be same correct or not everyone that's the benefit for Hindustan univer Hindustan univer company the greatest benefit is their sales won't jump suddenly their sales even don't fall suddenly Hindustan univer is an essential discretionary answer. A person who is using a particular shampoo generally won't change it very frequently and every one month if a shampoo comes or two months if it come every two months you will buy the same your sales are constant for them irrespect of anything happening outside answer yeah like that it won't happen in this industry in CA industry how it will be students mind changes just in one attempt yes or no at that time how come you will take risk in these kind of businesses you Now clear the first reason why I operate online classes now zero fixed cost my only fixed cost is this price understood everything is variable cost no student join nothing left what happens nothing nothing great for that book all other printing concept will be there no fixed cost one person is there who will take care of all these things the 30,000 I have to pay that is not a problem you understand yeah though it is discretionary I have zero fixed cost almost negligible my home is own my office is my own premises my own home is own home only there is no fixed cost for me almost zero there is only one person who is doing all this another person I should take care of 99% of the things my only investment is this I should only shout and understand.
That's it. So when I am into this, I can do whatever circus I want. You understand? Yeah. Who will stop? I will give free classes here. Who will stop me? No one can stop. I will give free classes. Take completely. What will happen? Nothing will happen. Clear?
That's what I wanted to tell. If you are in essential, have as much fixed cost as you want. If you are into discretionary, avoid fixed cost. This is the life thesis.
Tell me what is the life finance pieces number one. If you are into essential then do whatever circus you want. Nothing will happen. Your customers are constant always. If not this time next month again it will reoperate. But if you are into >> avoid what costs as much as possible have all variable costs only with the change in sales that also will change.
Clear everyone. 100 students came 100 books I have to print. 200 students came, 200 books I have to print. Zero students came no printing happy sit at home and should have happily eat grown and watch some movie who will stop you. This is how the businesses has to operate with this. We completed our grand introduction to this concept to understand the concept relating to labores. Okay, take a break and come. We will start after that and start doing the problem because even if I start doing the problems now time is not sufficient.
Take a break and come. We'll start and directly start doing problems in leverages chapter. Everyone had a full clarity. Yeah.
So we Continue.
Shall we continue everyone?
All the live students please give a reply. Can we begin?
Okay.
See here.
Okay. Once we going to begin see now we are going to start with problems on leverages chapter learning been completed.
Now application of the learning is pending which we will cover now set one by one let us take the questions and start solving 10 mark question we will start directly with the big Huh?
Okay. See everyone visible. Everyone see following are the selected financial information of A limited and B limited for the year ended March 31st 2021 variable cost ratio. Variable cost what my variable cost ratio one second we started some people are looking somewhere else I will throw you outside the class due to over action I'm very serious about it class started please see here to whom I am saying they know very well I don't have a habit of pointing out anyone see there class started please variable cost ratio means or variable cost divided by sales. Okay. So variable cost is 60% of the sales in B limited variable cost is 50% of the sales. Okay. And if sales is 100 variable cost 60 in company A in second company variable sales is 100 variable cost is 50. Understood a meaning of 60 50. Okay. Interest cost given. Okay. Now answer I have one or two questions first to ask variable cost ratio what is the formula variable cost ratio what is the formula variable cost divided by sales will give you 60%.6 6 and variable cost by sales will give you.5. Correct. Okay. Now answer missing figures calculation. What is the formula for operating leverage?
Don't tell percentages because 2 years data is not given.
This is not two years data. This is to company's data for one year. So tell me C only A limited. Forget about B. Tell about A limited data. What is the formula for operating leverage for one year data?
Contribution given or not given up? Not given. Okay. Now again another question.
Financial leverage is given or not given aveniven.
>> Financial leverage.
>> Sorry. Don't do anything. I will first do one thing and I will explain you answer to the question. He is asking us to calculate it. Next. Next fourth bit you will keep it away that's a decision making first three bits you tell me after seeing that what you understood those three details when they asked what you understood after seeing them income statement >> very good income statement filling what I told you at the beginning of this chapter this chapter is nothing but filling the income statement that's all if you have ability to fill income statement you'll get six on six in exam clearer Nothing will in this chapter very simple. Understand three leverages.
Understand three concepts. PV ratio, margin of safety, break even point, >> operating, financial leverage, combined leverage, income statement. That's all.
If you have having a good grip over income statement, three leverages, three concepts, chapter completed.
>> Yesterday, today complete discussion is on these seven points.
>> What are the seven points? Income statement.
ratio, break even point, margin of safety, operating leverage, financial leverage, combined leverage and we also added some points operating risk financial financial risk combined risk.
It is not a separate discussion.
Leverage first concept is risk completed all those. Now we are into the problems. Pen should not stop. We should start doing as many number of problems as possible. Okay. But before that I wanted to ask you one thing. Tell me sales minus uh minus uh >> very good. Next.
Uh >> tax given or not given a answer.
Huh? Hey >> that's it up to here he asked number of shares not given combined leverage not asked therefore EPS has no relevance >> combined leverage if they ask now chance is there at least anyway this is not a percentage computation correct so what are the companies here A B first tell me one answer I will first do for A you tell me the answer first what is the financial leverage Answer three.
>> See there?
>> Financial leverage. What is the answer?
>> Tell me financial leverage is three.
Always remember if you want EBIT. If you want >> when interest is given when what is given?
>> Use financial formula. How? See there.
What is the formula for financial? Can you please tell me?
divided by EBT equal to what?
>> I want to ask one question. What is EBT?
>> Huh? Don't don't expand. What is EBT?
How you obtain EBT?
>> EB income statement you see and tell EBIT minus what >> gives you what?
>> Interest is given or not given. That's it. One missing figure we can use. See here eB H divided by minus equal to how much?
>> Three. Okay. Now EB it divided by >> EB it minus equal to how much? Three. Uh continue. EIT equal to >> 3 EBIT minus 60,000. Uh next 2 EBIT = EBIT equal to one missing figure is computed successfully correct. So first one over tell me what is the EBIT?
30,000 is the EBIT. What is the interest?
Very good. Next, what is the EBT?
What is the tax?% how much percent 30%. So how much what is the eat?
Suddenly entire income statement down this line below the EBIT is filled.
Now answer we know EBIT.
We know >> EBIT. Now see the question and tell what is the formula for operating leverage contribution by EV. We know EBIT. We know operating leverage number. Can we calculate contribution or not? So now tell me uh this is EBIT computation.
Step one B. Oh sorry step one. Step two tell me what is operating leverage? Answer.
No answer. Answer he has given in the question. Operating leverage five tell the formula now contribution by equal to 5 contribution what is EBIT just now we computed equal to so contribution equal to how much 1 lakh 50,000 so contribution is 1 lakh 50,000 so 1 lakh 50,000 is contribution uh EBIT is 30,000 means can we calculate the balancing figure has a fixed cost.
Tell me what is the balancing figure?
One lakh.
>> Very good. Now tell me >> variable cost ratio is how much?
>> I will ask a question. Answer sales will be 100%.
Variable cost is 60%. And the contribution 40% if it is 1 lakh 50 can we calculate what is 100%?
Calculate 1 lakh 50 into 100 divided by 40. How much? 3 lakh 75,000.
What is the balance? 375,000 - 1 lakh 50.
>> Answer,000.
Okay.
One second. Just a minute. Okay. Answer how much 2 lakh 25,000.
Now answer my question. They asked the EBIT, had you calculated? They asked sales calculated. They asked the fixed cost calculated. That's all for company A. We failed. Will you do for company B?
>> Do it for company A. First copy down this. Do it for company B.
Now you understood the importance of income statement.
question hey I have kept this question mark in my telegram group also available okay I will give the details also freely it is available you can download okay yesterday's cost of app also I have given them they will share it with you okay full question bank I already shared in my telegram group if you have the details you can download You need not copy the question. Question mark already kept in my telegram group.
You can download you. Just concentrate on answering.
The students in live also please give a reply. Did you see the question mark man share it on the telegram group in our WhatsApp groups and telegram group I already openly shared the document you can take it after students please do it properly first completed company B limited completed how many how much time you will take easy now one thing we are already done repeat the same also for another Tell me what is the answer for B limited EBIT?
B limited EBID sales sales 8 lakh sir fixed cost for those who couldn't do at least I will do now same for which company we are going to do now be limited tell me what is the for what is the financial leverage given in the question 2 EBIT divided by EBIT minus 1 lakh = 2 EBIT equal to 2 EBIT minus 2 lakh so EBIT equal to 2 lakh so income statement EBIT will be 2 lakh What is the interest cost given in the question? One lakh.
So, EBT will be 1 lakh. Tax rate is 30,000.
Answer is 70,000.
Next, we know EBIT equal to 2 lakh.
Operating leverage tell me operating leverage formalize contribution by how many times? Two times >> again two. Okay. So contribution divided by EBIT. How much is the EBIT? 2 lakhs equal to two. So contribution will be equal to how many lakhs? Four lakhs.
Then how much will be the fixed cost?
Two lakhs.
Next PV ratio in this question is how much?
50. So this will be 50, this will be 50 and this will be 100. If four lakh is the contribution, how much will be variable cost? Four lakh sales will be 8 lakh. So now sales EBIT 2 lakh sales 8 lakh fixed cost 2 lakh.
This is the answer for the given question.
Everyone understood how the working is done to be up because I prepared the income statement. Can you move on to the next one? See here next question.
H last point.
Hey listen after learning so many things I wanted to ask you one question because first part of the you are copying that Okay, ma'am. Can I continue to the next one?
Hey, answer. Can you continue next?
So we now completed the first one. This is the answer for the income statement.
Last bit answer. See with the knowledge that we have a listen.
See there can be A matrix written like this.
See there.
Listen.
Situation one.
Okay. Listen. Listen.
Okay.
In instead of like writing like this wait I will first write down in one format to try understanding inside the box itself I will write for your clarity listen four situations can come high operating leverage okay I write I will write like this low operating leverage low financial leverage High operating leverage.
Low financial leverage.
Low operating leverage.
Higher financial leverage.
Higher operating leverage.
Higher financial leverage.
Okay. See.
Listen.
What is the first case?
Low operating leverage, low financial leverage. Fourth case, high operating leverage, high finance leverage. Second case, high operating leverage, low finance leverage. Next, >> low operating leverage, higher financial leverage. Which is a dangerous combination? Which if the safest combination is a question now okay now you answer my question we are having two companies with us in our question here you have written the answer sir in the question you tell me there are two companies A limited another one B limited tell me what is the operating leverage and financial leverage answers for both the companies A limited tell both operating financial five and three okay Next to B.
>> Two and >> two.
>> Two. Okay. Now tell me which is the safest company. If you ask what is the safest one? Both are same.
Therefore B 53 difference is there therefore not. That is not the way. When you answer something you should answer from the background what you learned in the first part of the class.
Say if you could not understand that I will ask some small small questions answer them everyone in the class please listen carefully again I'm telling you we are not dealing with any stories here every minute will turn into marks if not marks at least into knowledge see that answer my question what is the nature of limited high operating risk low finance risk Next B. Same level of operating risk as well as in answer risk. See, I asked you one question in the first part of the class. Just answer that. Why EPS changes?
Why EPS changes?
>> E changes.
>> E chain.
>> Why EB change?
>> Huh? E. Why ev change?
>> Why contribution change? Ah stop with that. Now I ask a question. Sales did not change. Then what will not change?
>> Contribution do not change. Then what won't change?
>> Now answer financial risk will come only what changes?
Start again. You are not listening.
We have written everything broken the total income statement into two parts.
Part one is called as what risk? Part two is called as what risk? No operating risk means no finance risk and the financial risk emerges from what operating risk can not there means finance risk will be there will not be there. That's why a company can take as much amount of finance rate as if we don't have a business risk.
If you don't have a business comes from what that comes from what nature of product and service we discussed already in the first part of the class.
So answer to my question high operating risk repeat what I said is more riskier than higher finance risk because finance risk is a risk which comes only when there is an operating risk operating risk not their needs financial risk will not influence your company because if your company don't have operating risk then what will happen EV8 won't change what won't change >> even won't change EV won't change E won't change EPS won't change so then what way of financing if you do what problem is there so therefore which risk is the source also called as which risky is the source business risk if business risk itself is not there no financial risk so companies having high operating leverage is dangerous Company having low operating leverage is dangerous.
Operating leverage is very very dangerous. Listening everyone in this company operating leverage can be called as water.
Financial leverage is called as water.
Tell me who is having a conservatively not higher not lower a stable operating and finance risk.
Which is having high operating risk?
>> A.
>> Which company is more dangerous to invest?
>> That's what the answer. That's why what he said. See here. Identify the company which is better placed. Tell me which is better placed company.
>> Lou proudly.
>> Read this what they have written.
Company A is better, company B is better because it is having equal amount of dash and dash operating risk and financial almost it comes under first category low operating leverage, low financial leverage.
But this company is in a dangerous situation. Okay. B limited in 1 2 3 4 matrix which is the most safest one. The best one you tell say what is the best one.
What is the best one loudly?
Third one.
Third one. Do you know how you are answering State Bank of India investment is better or TCS investment is better? Means you are telling State Bank of India. When you don't take any risk, returns also won't come. You should invest in such a place where risk should be there but return should be more see concept if you want to understand I will tell you this way state bank of India people will invest in FD cor who will invest in FD in my life never I opened any FD in my entire life last 32 years never I opened any FD in my name neither in any of my family member game I hate fixed deposits because I don't want that 7% 6% returns I want minimum 15% 16% returns so never my concern is about FD FD is riskier not riskier answer not at all risky it comes under lowest operating leverage lowest financial leverage now tell me your money you will invest in state bank of India FDI if you are having good wealth to invest somewhere you will invest in SBI. No, you should invest in such a place where the company's business should not be at risk.
Repeat what I said company should not be at risk. Financially, you can take a circus risk but your business should not be at risk.
Understood the point clearly. Yeah. Your business is at risk means I can't invest in such kind of business.
Listening, listening, listening. What is the classic example of a business failure?
Classic example shall I tell you? Open fat by juice.
You know by juice by juice company you know now one company is there after flop. Do you know how failed? Do you know how much super hit once upon a time it is? Suddenly it fell down like anything became a zero also correct operating risk. They invested lot of money in fixed costs. They opened branches physical. See sir everything link around you lot of examples are there so many financial failures you are seeing every single day you should know the reason and you should not repeat and you should also give advices to the known people clearly logic is very simple yeah what is the nature of your business study that clear I have a cla is in which industry everyone need compulsion everyone after getting born you should do charted accountancy or cost account guarantee or there is any compulsion so there is no compulsion 100 one or two only will join this remaining will go to different different courses available so I know very clearly one thing the moment when I taken my classes itself I decided one thing in life never ever start an offline academy I never have the thought if you want you can come as a freelancer share knowledge and we can go but never in my life I had ever had an intention of starting an offline academy I won't start also I had always an ambition that I should become number one in online and working on them every single day and night reason I have no fixed cost everything I do will turn into revenue if I really do properly do you understand I know very clearly about this industry this industry is an essential discretionary This patient risk of business is higher low business risk models. These are in a high business risk model. You should never put lot of money.
Isn't it? When you can put high money in a business risk model, when there is a efficient management, you can put money.
Isn't it? If efficient management is there, yes, certainly you can take that risk. But always try to understand this industry fixed cost should be not lesser as low as possible you keep for making money. The moment you start putting money on fixed cost like opening buildings taking buildings taking branches this won't work because this industry like everyone will see success one day failure also one day. This is not new for us now. Last 13 years been seeing like this they will go like this they will fall. When they are at this level now they should be down to always block one point in CI industry. Now when you are at the top you should be more humble than when you are in ground BECAUSE DEFINITELY YOU WILL COME DOWN one day that day no one will help you.
Clear? So many visible evidences.
So when you are in the top people will see how you are behaving. So when you are coming down the people will help you. This fellow is coming down we should help him to push up or else sir come down come down we will show how it will be platform also you should see. So the other problem in this industry in this industry that humbleness is what required. So when you are in the top how you behave is most important than when you are in top down because chartered accountant they don't understand how this industry operates means what is the point? So please everyone when you qualify you wanted to take a venture listening you take risk where you can take risk in your practice as a CA you take risk because audits are mandatory essentials audits are mandator company means what is mandatory audit means who is mandatory auditor means charted account both can do the audits so there again it is essential There you can do lot of circus.
I think you can understand my point.
Basic finance knowledge. This this does not require Einstein knowledge. Basic finance. What is the nature of my business? This business will ensure compulsory confirm returns are or will not give. I see I will give you an example. My very close friends are there. So many friends are there. Okay.
They are doing practice. See I said they are doing practice. They are not into this.
They are having around 100 to 150 clients there. Every single month GST returns they have to file. Each return they will charge somewhere around 700 to,000 small returns. Just a simple returns 1,000 into 150. 1 lakh 50,000 fixed income they will get every single month. This is on GST. TDS companies that file other labor filings like ESIBF all these they earn around two and a half lakhs per month fixed I'm not talking variable along with this sudden internal audits stock audits bank audits revenue audits concurrent audits all these put together during a year they are adding somewhere around 30 40 decent amount of lakhs and they're very happy in the 30 lakhs revenue they earn at least 90% is every Do you understand what I said? They can take a premises lavish infrastructure.
they can do reason next 10 years client won't leave you and go out because clients won't take risk of changing articles are you understanding huh in my in my my experience if I have to tell you if we are having around 73 companies are there in my audit now previously when we have 75 76 30 clients left us that's all clients won't leave you generally 99% of the cases they won't either client should die perpetual succession so many time so many of our clients have died so either client should die or their business should be almost gone like that it should happen 99% of the cases they don't leave auditors they don't change auditor They don't like it.
Whatsoever you do, they don't change.
So listen, therefore why I'm telling this life lesson always is you are into essential discretionary CA >> discretionary >> discretionary discretionary businesses.
See CA is essential on audit side. CA course is discretionary. There is a lot of difference between both of them or not. In this you should be very very vigilant. Who makes money in CA course?
Those who have lower fixed cost they will make good money in this because variable cost will anyway change along with the output and number of units produced or not. Here number of unit is the number of students like that you can understand isn't that number of students more so automatically uh number of students more means per student cost also will increase to them number of student reduce now that will also reduce so logic is very simple don't stop taking risk take risk but when you take risk use your common sense listening to invest Which kind of businesses so you should put more money?
Which kind of business essential discretionary? I'm not asking even discretionary also you can keep. Which kind of labored companies you should invest high high finance leverage low low.
Your business should not be at risk.
But tell me which is a super best combination to make out money out of it.
Low operating risk finance risk. If you have high finance system, more EPS will come.
What I said if you have high finance risk, more EPS will come. Isn't it? If you are having high operating risk, EB won't come.
EPS give to God. At least what also will not come. Tell me if you have more operating risk what also will not come.
>> But if you have lower operating risk now first EBT will come on EBT how many people are dependent from EBT how many people will take equity debt preference or equity preference equity repeat >> start againity >> three types of capitals are there. Yes sir. Now you answer EBIT. How many people will be dependent on? How many people will take money from EBIT?
Answer. How many people will take money out of EBIT? How many people are dependent on that?
>> Loudly.
>> Four. Government.
Though money invested by three people, dependency is by four people. First EBIT, interest will be taken by deentures and deentures not just deure or debt. Next government will come and take the tax. Next preference will come and take the preference. Finally, if there is anything remaining, equity will take it. Clear everyone logic is very simple. Huh? See, have low operating risk. Have such that you will get more such that you will get more eBay >> or at least EB will not be affected.
Okay. When EA is not affected, happily EBS will generate listening everyone. So tell me what is the best combination?
What is the worst combination?
High operating leverage, low finance leverage will be there. Those are at risk.
Do you understand the point?
Answer sir.
So this is the situation. is the best one the worst one. Okay sir why not last one is the worst one sir whenever you take highest risk there is also a chance of getting higher returns clear but second case you won't get this you won't even get that so very dangerous concept okay sir I will tell you about this much later with problems first of all everyone understood this question clearly yeah that decision making you need not right just write down company B is better than company A Company B is better than company A.
Company B is better than company A.
Can I move on to the next question?
Yeah.
Okay. See here, see here following information is relating to YZ limit company limited for the year ended some year. Equity share capital with rupees. Equity share capital rupees 10 each. 50 lakh 12% bonds rupees 1,000 each 37 lakh sales fixed cost excluding interest financial leverage profit volume ratio income tax required to calculate the operating leverage combined leverage earnings per share this is the details given okay this is the question already this question came in examination for eight marks read the question properly before we start with the solution.
Read the question.
Understand the facts properly.
Read the question normally first.
Okay. Uh one by one. Now answer point number one. Hey listen.
Answ answer. What is the financial leverage given in the question?
H uh.
>> Okay. I will ask you a question to calculate all these three. First what is required? Still income statement. Keep the heading. Step one, income statement.
Step one, income statement.
Okay, this is the detail first. What is the habit? Good habit in the chapter. Now, fill whatever data is given in the question. First tell me first thing sales are given or not given up see I'm drawing a line for your reference okay these are the details first tell me sales how much is given in the question right next data given next data given What is the next data given?
Huh?
>> Fixed cost. How much is the fixed cost?
Correct.
Answer.
Next. Interest cost we can calculate because 12% bonds 37 lakhs given. So 37 lakhs into 12% will give the interest cost or not.
4 lakh 44,000 write down 37 lakhs into 12%.
4 lakh 44,000.
Okay. This detail also available. Next.
Next. What is the next detail that is available yet? Number of shares is available. 10 rupees each 50 lakh means how many lakh shares are there? Five lakh.
Okay.
Hey, answer.
Hey, listen.
EBIT minus interest is EBT. Correct.
Sales given PV ratio is given. Can we calculate the contribution?
What is the formula for PV ratio?
Write down below. Working note one.
Calculation of contribution PV ratio or contribution by sales equal to 2755.
2755 contribution we don't know sales we know already how much 84 contribution equal to 23 lakh 14,200 return balance and see the variable cost right now.
Copy down up to here.
Hey, copy down the income statement up to here. live streams also. If you have any doubt, you can put it Okay, everyone completed?
Okay, tell me now what is the EB ID? 23 lakh 14,200 - 6 lakh 96,000. Tell me the answer.
There you go.
16 lakh 18,200 is what cost?
H sorry is what income? Operating income also called as what? EB RT up to here everyone tell me understood.
Okay. Now answer we are not at done. Please listen.
What is the financial leverage given in the question?
The bad response you are giving here.
What is the financial leverage given in the question?
What is financial leverage formula for one year?
What is the financial year formula?
>> EBIT by >> Okay, take calculator. What is our EBIT?
16 lakh.
>> Okay, I'm writing roughly here. Below write down working node 2.
Okay. Uh below write down first financial equal to how much given?
1 >> 4 49 Okay, great. 1 minute everyone see here roughly you tell don't write anything don't copy first answer EVIT is how much 16 lakh >> 18,200 minus interest is 4 lakh 44,000 how much is the EBT sir don't write don't write I'm writing here roughly 11 lakh 74,000 very good now you answer what is the formula for financial EBIT by >> EBT.
>> EBT equal to how much?
>> 1.49. What is the EBIT?
>> 16 lakh 18,000 uh divided by 11 lakh 74,200.
Tell answer >> tell tell one point >> 38 >> 38 >> 8 and how much it will be 1 39 but it's not matching that's the new point we are going to learn in this question see that's why I'm saying please see the screen eB is how much how much is a financial leverage given in the question 1.4 >> okay but when we really calculate using the EBT that we got it's not equal to 1.49 49 it's equal to somewhere 1.38 something correct. Therefore there is some important missing data in this question that we need to compute in this question. So that's why see the screen once. See what is the formula for financial leverage?
>> EBIT by equal to how much?
EBIT is how much?
>> 60 18,000 divided by EBT equal to 1.49.
So EBT equal to do it 16 lakh 18,200 divided by 1.49. How much? 10 lakh 86,000 See here see here see here don't write 10 lakh uh >> 8600 >> 86,000 40 do you know what is the meaning how much how much is eBay calculator 16 18,200 minus what is the interest 4 lakh 4 lakh 40 16 18,200 minus 4 lakh 44,000 how much it is very good but we got how much here what is the difference 10 lakh >> 10 lakh 86,40 how much 88,000 >> that will be other fixed cost 88,160 60 has to be reduced. Balance has become EBD. Okay. Tax tell me how much is the tax? 1086,00040 into 4 how much it is >> 1086,40 into how much% 40 how much? 4 lakh 41 416 reduce. Tell me what is the EAT?
>> 651 51,000 >> 6 lakh 51, 624 divided by 5 lakh shares how much it will be 1.33 per share. This is the EPS. See what he is asking. Now listen what is the formula for operating leverage?
What is the formula for operating leverage?
What is the contribution?
23 14,200.
Okay. Divided by what is the EBIT?
>> How much it is? What is the operating leverage?
Operating leverage equal to contribution divided by EBIT. What is the contribution? 23 lakh >> 14,200 divided by what is the EBIT given in the question?
16 lakh 18,200 tell me how much it is 1 43 Next one combined leverage operating leverage into financial leverage 1.43 into 1 9 >> 1.43 into 1.49 4 9 how much 2 that's it this is the answer sir what is the new point we learned in this question EBIT should be calculated on income statement on financial leverage basis financial leverage but it if you follow the income statement it will be some number but as for financial leverage a different number is coming means what some other fixed costs the finance and fixed costs are there which are not considered there you know so that is 8 88,100 60. See here, let us check our answer.
Whether it is right or not 2.13 is the right answer. That's it. If that is right answer, everything we have done is right. 1086,40.
Check this income statement. Had we done in the same way?
Have we got the same answer or not?
Everyone what is 88, 160 other fixed interest or other fixed cost whatever the case may okay you can copy I'm sorry.
Everyone tell me have you understood the concept clearly? Yeah. Second question.
Can you move on to the next question?
So copy down.
Okay.
Can we move on to the next question everyone?
Yeah. Answer theory questions. Please, please, please.
Theory questions I'm not doing anyway.
Not now. This is not the time to learn about the theory part.
Okay. Good question.
Came in exam for 6 months.
Let's do this. See here.
Okay. See see the screen once.
Capital structure of capital structure of Ansu limited asset 313 2019 consisted of ordinary share capital and equity share capital of rupees 5 lakh face value 100 5,000 shares 5 lakh 100 rupees means 5,000 shares 5 lakh 100 means 5,000 shares sir 10% debentures of five lakh 100 each again 5,000 debentures 10% interest cost in the year ended first uh in the year ended with March 19 sales decreased from and what is decrease volume is reduced decreased from 60,000 to 50,000 units during this year and in the previous year selling price was 12 rupee per unit variable cost is eight fixed expenses one lakh income tax rate is 30%. If you observe what we discussed in the class is presented in the form of a question here. Then what is our entire classroom discussion for one full hour before the break analyzing the impact of increased sales reduce user sales. All that question is asked in exam for 6 months.
Next you are required to calculate the following percentage of decrease in EPS degree of operating leverage at 60,000 units and 50,000 units. Degree of financial leverage at 60,000 units and 50,000 units. What will be our common step in this chapter? First without that you can't do anything in this chapter. First let us start with the income statement but don't write entire income statement because s you do one thing write up to EPS normal schedule you write on. Okay.
Income statement question number six we are going to do. Okay.
When you write don't talk when you write income statement itself write down clearly like this 60,000 units 50,000 units no waste of time two times you need not do directly we can do both at a time right now First sales minus variable cost contribution minus fixed cost EBIT minus interest cost EBT minus tax at the rate of 30%.
EAT divided by number of shares EBS.
Shall we begin everyone?
Hey, I'm talking to you everyone. Shall we start answer to the question and do uh first one? Which question we are doing?
If I concentrate on you will not even come to one.
See listen listen first point number one what is the sale price per unit 100 remaining 88 you give me after class every other person take 12 is How many units are sold in the first case? 60,000 into 12 answer. Yeah.
Write down 60,000 into 12 7 lakh 20,000 is the sales in the first case.
This question is exact replica of our discussion before break.
Okay. Anx 50,000 into 12 how much?
If you remember this also observation we made. Whenever I say there is a fall, fall is in the units not in the prices.
Did I discuss about that point or not?
There is a market drop will be on the volumes not on prices. Okay. So variable cost how much here? See question given 8. So 60,000 into 8 how much?
4 lakh 80,000.
50,000 into 8 will be 4 lakh.
Next contribution 7 lakh 20,000 2 lakh >> 40,000 Next two lakhs.
Next one. What is the fixed cost given in the question? one lakh EBIT 1 lakh 40,000 1 lakh next did they give any interest cost in the question see Deentures are carrying 10% on this five lakh they will change with the sales volume will be constant interest will change according to sales constant five lakh into 10% how much is the EBT 90,000 tax is how 30%. 90,000 into 30% is 27,000.
This will be 15,000.
E8 E8 63,000 35,000 Number of shares 50,000 50,000 EPS 63,000 divided by 50 1.26 26 0.70 fill the income statement first everyone are you all understanding and saying yes sir everyone I'm believing in you that you are understanding and doing Hey hey shares are 5,000 only not 50,000 very sorry it's not 100 rupee per value sorry it's not 10 rupee per value 100 5,000 shares 12.60 and uh concept won't change numbers will change EPS 12.6 6 and 7.
Yes.
Okay. Now answer sir. Hey listen.
What is the percentage change in sales?
Can we calculate 50,000 60,000 sales became 50,000 means?
Can you calculate the percentage of fall?
Write down below.
Number one, percentage change in sales. Tell me what is the percentage change in sales?
How much fell to how much?
60,000 fell to 50.
Okay. Bye everyone.
Huh?
Huh? You can take seven lakhs also. No problem. Sir, if you wanted to do a number amount of sales, tell me previously.
Previously, how much it is?
7 lakh. Fell to how much?
Tell the percentage changes 16.67.
So the fall is -6 67 percentage. -6.67 percentage.
But in the question what they asked percentage decrease in earnings per share percentage decrease in earnings per share.
Write down decrease in EPS percentage.
Okay, sorry. 12.6 12.6 - 7 divided by 12.6 into 100. How much is the change here?
fall by 44 44%.
It started with 12.6 ended with 7 always whenever you take it whatever we started that should be in the base 12.6 things.
Okay. Next. What is the second question?
Degree of operating leverage. Okay.
Everyone write down operating leverage.
60,000 units.
50,000 units.
Everyone please tell me what is the formula for operating leverage.
What is the formula for operating leverage?
Write down what is the contribution?
60,000 2 lakh 40,000 here two lakhs.
What is the EB?
1 lakh 40 1 lakh Tell the answer what is the operating leverage 2K 40 divided by 1 lakh 40 1.71 times two times everyone please answer understood 1.71 times and two times number Four.
Next one they ask is financial leverage.
Write down clearly 60,000 units 50,000 units. Tell me the formula for financial leverage EBIT by EBD.
Everyone tell me what is EBIT? EBD 90,000 50,000 financial leverage equal to 1.56* 2.
That's it.
First of all everyone please tell me are you all comfortable with this chapter to hear clearly? Yeah.
Okay.
Next question. Have you all copied the answer?
Copy down the answer first.
completed answer sir completed everyone. Okay.
Next.
See here.
See here 10 minutes time six marks question five marks question one time five marks one time then six marks this question came with a slide chain start doing it this is a class question for everyone start doing Everyone start doing it.
Maximum time is 8 minutes.
Not even 10.
Pastly start doing the workings do the answer. Let us read the question.
Whenever question is given don't start writing anything read the question first then you'll understand what we need to start with.
Hey listen how many companies details are given here. A and B equity capital given deentures given output given output represents what? Volume one company six lakh another hey these are not two years six lakh did not become 1 lakh 50. This is company A. This is company B. So sale price, fixed cost perom, variable cost given. Details are given. They are asking operating financial company. Five marks. Can you do what you find the change in sales we take? So 10,000 we get otherwise same answer for change here already starting.
Completed everyone completed. Huh? Okay. Tell me, you should tell me three answers. A and B. Operating financial combined.
Operating leverage of A 1.
>> Okay. B 1 71. Next financial 1.0.
>> Next B >> 1.0 >> five. Next. Combine.
1 73 or 74. Okay. Next 1.
Have you all got the same answer?
Let us check now.
See operating leverage 1.64 and 1.71. Have you got the same answer?
Yes. 1.06 1.05.
Perfect. 1.74 1.80 perfect the right answer everyone did you now understand how to solve the questions on leverages next Okay. See this question.
See listen.
This is another question that came in exam for five marks. Let us understand firm PQR S change in revenue. Revenue represents salary percentage change in sales.
Operating income, percentage change in sales given, percentage change in EPS given and percentage change in EV given. He's asking operating leverage and combined leverage for all the three all the four.
First tell me what is the formula for operating leverage on percentage basis?
Perfect day change in EBIT by percentage change in sales. Next financial financial leverage percent change in EPS for a percentage change in EBIT. Combine that into this.
Let's start doing keep the heading for Keep the heading like this operating leverage.
Write down first I directly through calculator you do the answer firm P what is the percentage change in EBIT see there 25 percentage change in EVIT 23 divided by 21 right 92 30 divided by 27 1.11 36 / 24 1.5 30 / 20 1.5 Next next percentage change in uh financial is for percentage change in EBS by percentage change in EBI what is the percentage change in EPS 30 divided by 23 how much it is 1 30 next 26 divided by 3087 next 20 divided by 36.56 6 20 / 30 66 combined average multiply 1 96 966 84 1.99 approximated to 1.
Everyone answer this also everyone understood clearly. Tell me this particular question already formula we read in the last class itself correct just what I said this chapter is dependent on seven concepts totally number one >> income statement number two >> PV ratio B and margin of that also we will do questions okay next class we will do not now next class we will do questions on that so still we require another two to two and a half hours to complete this chapter once we complete we'll go into the next area after this okay what so once this is completed next chapter we'll start in the same way sir anyway till the third one what is the third concept first one income statement next ratio B all one concept next finally completely till now we have done that okay done these are all the answers ka everyone Okay, now listen.
Listen.
If if you read this question, you will understand whether had we already done or not. Capital structure of Roshion Limited for the year 31st March 22 consisted as follows. Equity share capital 10% deentures during the year 2122 company sales decreased to 15 lakh units as compared to 18 lakh units in the last year. So last year how many units are sold? Now fell to how much?
However, sale price should 120. Variable cost also student 80 per unit for both the years. Fixed expenses are 3 cr.
Interest income tax is 30%. They are asking degree of financial leverage operating leverage. Percentage change in EPS. Similar question we have already done or not.
Where you have done yes sir is the most easiest answer. I told you where you have done a question three this cap structure question you have seen or not okay do one thing take this particular question a snap or question bank is already there in my telegram group question number 13 is your homework question similar question to the previous one okay that already I have done this you practice at home Okay sir, listen listen.
Today I'm having another class after that I'm leaving you now. Tomorrow session we will continue the remaining 2 hours extra. Hey sir 2 hours we need to spend on the chapter another eight problems I will make you do different different 10 marks questions all six marks and eight marks questions we have done 10 marks questions I will show you we will do that once completed our next chapter will be dividends. Which one?
dividends chapter we will do after that we'll go into the next segment called as capital structure theories.
Thank you very much everyone.
Meet you again in the next class.
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