Summary of "10 Leverage From CA Inter Study Material (Financial Management )"

Summary of "10 Leverage From CA Inter Study Material (Financial Management)"

This video tutorial focuses on solving a Leverage problem from the CA Inter Financial Management syllabus, specifically question number seven from the Leverage chapter. The instructor walks through the problem step-by-step, explaining key financial concepts and formulas related to Leverage, Income Statement construction, and various Leverage ratios.

Main Ideas and Concepts

Context & Source of Problem The problem is from the CA Inter study material, Leverage chapter, question number seven, involving a balance sheet and financial data given in crores.
Given Data Overview
- Total assets: ₹20 crores
- Fixed assets: ₹12.5 crores
- Current assets: ₹7.5 crores
- Equity shares: ₹5 crores (50 lakh shares of ₹10 each)
- Reserve: ₹1 crore
- 15% Debentures: ₹10 crores
- Current liabilities: ₹4 crores
- Operating ratio (variable cost percentage): 65%
- Fixed cost: ₹4 crores
- Interest on debentures: ₹1.5 crores (15% of ₹10 crores)
- Tax rate: 30%
Step-by-Step Problem Solving Approach
1. Calculate Sales Using the Total Asset Turnover formula: Total Asset Turnover = Sales / Total Assets = 2.5 Given total assets = ₹20 crores, sales = 20 × 2.5 = ₹50 crores.
2. Prepare Income Statement
  - Sales = ₹50 crores
  - Variable cost = 65% of sales = 0.65 × 50 = ₹32.5 crores
  - Contribution = Sales - Variable cost = 50 - 32.5 = ₹17.5 crores
  - Fixed cost = ₹4 crores
  - EBIT (Earnings Before Interest and Tax) = Contribution - Fixed cost = 17.5 - 4 = ₹13.5 crores
  - Interest expense = 15% on ₹10 crores = ₹1.5 crores
  - EBT (Earnings Before Tax) = EBIT - Interest = 13.5 - 1.5 = ₹12 crores
  - Tax (30%) = 0.30 × 12 = ₹3.6 crores
  - EAT (Earnings After Tax) = EBT - Tax = 12 - 3.6 = ₹8.4 crores
3. Calculate Earnings Per Share (EPS) EPS = (Earnings After Tax - Preference Dividend) / Number of Equity Shares = 8.4 crores / 50 lakh shares = ₹16.8 per share
4. Calculate Operating Leverage Operating Leverage = Contribution / EBIT = 17.5 / 13.5 = 1.296
5. Calculate Financial Leverage Financial Leverage = EBIT / EBT = 13.5 / 12 = 1.125
6. Calculate Combined Leverage Combined Leverage = Operating Leverage × Financial Leverage = 1.296 × 1.125 = 1.458

Key Formulas Highlighted

Total Asset Turnover = Sales / Total Assets
Contribution = Sales - Variable Cost
EBIT = Contribution - Fixed Cost
EBT = EBIT - Interest
EAT = EBT - Tax
EPS = (Earnings After Tax - Preference Dividend) / Number of Equity Shares
Operating Leverage = Contribution / EBIT
Financial Leverage = EBIT / EBT
Combined Leverage = Operating Leverage × Financial Leverage

Lessons & Takeaways

Understanding how to extract and use financial data from balance sheets and income statements to calculate Leverage ratios.
Clear stepwise approach to solving Leverage-related problems in CA Inter Financial Management.
Reinforcement of concepts such as contribution margin, EBIT, interest expense, tax impact, and Leverage ratios.
Emphasis on the practical application of formulas in exam-style questions.