NIOS Class 12 Business Studies Chapter 10 Fundamental of Management

NIOS Class 12 Business Studies Chapter 10 Fundamental of Management Solutions to each chapter is provided in the list so that you can easily browse throughout different chapters NIOS Class 12 Business Studies Chapter 10 Fundamental of Management and select need one. NIOS Class 12 Business Studies Chapter 10 Fundamental of Management Question Answers Download PDF. NIOS Study Material of Class 12 Business Studies Notes Paper 319.

NIOS Class 12 Business Studies Chapter 10 Fundamental of Management

Join Telegram channel

Follow us:

Also, you can read the NIOS book online in these sections Solutions by Expert Teachers as per National Institute of Open Schooling (NIOS) Book guidelines. These solutions are part of NIOS All Subject Solutions. Here we have given NIOS Class 12 Business Studies Chapter 10 Fundamental of Management, NIOS Senior Secondary Course Business Studies for All Chapter, You can practice these here.

Financial Planning and Management

Chapter: 10

Module – 3 Business Finance

INTEXT QUESTIONS 10.1 

1. A company plans to buy a latest machine which operates on new technology in order to replace an old and outdated machine. Identify the type of decision involved: 

(a) Investment decision. 

(b) Financial decision. 

(c) Dividend decision. 

(d) All of the above.

Ans: (a) Investment decision.   

2. A company decided to distribute a portion of the profits earned in the previous years among its share holders. Identity the type of decision involved. 

(a) Financial decision. 

(b) Investment decision. 

(c) Dividend decision. 

(d) All of the above.

Ans: (c) Dividend decision.  

3. A company assured the funds required to execute an expansion programme. Identify the decision made by the company. 

(a) Financial decision. 

(b) Investment decision. 

(c) Dividend decision. 

(d) None of the above.

Ans: (c) Dividend decision.  

4. Financing decision relates to: 

(a) Liabilities side of balance sheet. 

(b) Assets side of balance sheet. 

(c) profit & loss account. 

(d) All of the above.

Ans: (a) Liabilities side of balance sheet.  

5. Investment decision relates to: 

(a) Investment in fixed assets. 

(b) Investment in current assets. 

(c) Portfolio investment. 

(d) All of the above.

Ans: (b) Investment in current assets. 

INTEXT QUESTION 10.2 

1. Wealth maximization objective of financial management relates to: 

(a) Increasing profit. 

(b) increasing revenue. 

(c) earnings per share. 

(d) all of the above. 

Ans: (c) earnings per share. 

2. Wealth maximization is superior to profit maximization because it considers: 

(a) Time value of money. 

(b) competition. 

(c) cost. 

(d) capital structure.

Ans: (a) Time value of money. 

INTEXT QUESTION 10.3 

1. Which of the following are not the essential characteristics of financial planning? 

(a) Simplicity. 

(b) Liquidity. 

(c) Abundant availability of funds. 

(d) Flexibility. 

(e) Concentration on long term needs only. 

(f) Economy.

Ans: (a) Simplicity. 

(c) Abundant availability of funds. 

(e) Concentration on long term needs only. 

2. State whether the following are objectives of financial planning, by writing ‘Yes’ or ‘No’. 

(a) Determining the requirement of fixed and working capital. ( )

Ans: No. 

(b) Determining the sales output. ( )

Ans: No. 

(c) To ensure the timely availability of funds. ( ) 

Ans: Yes.

(d) To determine the quantity of production. ( )

Ans: No. 

(e) To raise funds at the lowest possible cost. ( ) 

Ans: Yes.

INTEXT QUESTION 10.4 

1. Balance Sheet of a company is given as under:

You are required to find out (a) Equity fund; (b) Debt fund; (c) Capital Structure; (d) Financial structure.

Ans: (a) Equity fund= Rs. 17,000.

(b) Debt fund= Rs. 28,000.

(c) Capital Structure= Rs. 45,000.

(d) Financial structure= Rs. 70,000. 

2. A high geared company is exposed to: 

(a) Business risk.

(b) financial risk. 

(c) inflation risk. 

(d) all of the above. 

Ans: (b) financial risk.

3. High level of gearing means: 

(a) Proportion of long-term debt to shareholder’s funds is low. 

(b) Proportion of long-term assets to shareholder’s funds is high. 

(c) Proportion of fixed assets to total assets is high. 

(d) Proportion of loan funds to net worth is high.

Ans: (d) Proportion of loan funds to net worth is high. 

INTEXT QUESTION 10.5 

1. From the following information, calculate: (a) Operating Leverage; (b) Financial leverage; and (c) combined leverage.

Ans: (a) C/EBIT=1.5.

(b) EBIT/EBT =2.

(c) C/EBT= 3.

2. A company produced and sold 20,000 units with a variable cost of Rs.20 per unit and Rs.30 per unit as selling price. The fixed overheads during the period was Rs.1,00,000. The operating leverage of the company is: 

(a) 1 

(b) 2 

(c) 1.5 

(d) 2.5

Ans: (a) 1. 

3. If the operating leverage is 3 and financial leverage is 2, the combined leverage is? 

(a) 1 

(b) 2.5 

(c) 4 

(d) 6 

Ans: (d) 6.

4. If combined leverage is 5 and operating leverage is 2, then the financial leverage is: 

(a) 3 

(b) 4 

(c) 5 

(d) 2.5

Ans: (d) 2.5. 

INTEXT QUESTION 10.6 

1. Fill in the blanks by choosing the correct answer. 

(a) When a company sell its shares directly to a small group of investors like bank, financial institutions, mutual funds etc, it is called as ………..(private placement, public issue, right share) 

Ans: Private placement.

(b) Retained earnings is an example of………..( fixed capital, current assets, liquid assets).

Ans: Fixed capital. 

(c) Rights issue is very ……….. to collect fixed capital.(economical, expensive, neutral)

Ans: Economically.  

(d) Fixed capital is capital that we invest in …………..(fixed assets,current assets, fictitious assets)

Ans: Fixed capital. 

INTEXT QUESTION 10.7 

1. Fill in the blanks: 

(a) Working capital refers to the excess of current assets over…………..

Ans: Current liabilities.  

(b) Gross working capital means investment in …………………… 

Ans: Current Liabilites.

(c) Liquidity means closeness to……………….. 

Ans: Cash.

(d) Inventory is the component of ……………………..

Ans: Current Assets. 

(e) Payment of loan instalment is ……………

Ans: Current Liabilities.  

(f) Working capital is needed for meeting expenses of the ………….business.

Ans: Operation. 

2. State whether we require ‘more’ or ‘less’ working capital in the following cases: 

(a) A company manufacturing Iron & steel.

Ans: More. 

(b) A bread manufacturing company having high inventory turnover.

Ans: Less.

(c) A large size business enterprise making toys.

Ans: More. 

(d) Company manufacturing furniture against orders only.

Ans: Less. 

(e) A company manufacturing coolers/refrigerators.

Ans: More.

3. Match the items in column A with column B. 

Ans:

4. Balance Sheet of a company is given as under:

Ans: (a) Rs.20,000. (b) Rs. 6,000.

INTEXT QUESTION 10.8 

1. Give the full form of the following abbreviations. 

(a) PAT.

Ans: Profit after tax.  

(b) FBT. 

Ans: Earnings before tax. 

(c) EBIT.

Ans: Earnings before interest and tax. 

2. In a company form of business, the wealth created is reflected in the of its shares. 

(a) Dividends declared. 

(b) Dividend growth. 

(c) Market value. 

(d) Assets value.

Ans: (c) Market value.  

3. The dividend decisions are concerned with: 

(a) Determination of quantum of profits to be distributed to the owners. 

(b) The frequency of such payments. 

(c) The amounts to be retained by the company. 

(d) All of the above.

Ans: (d) All of the above.  

4. The buyer of an ex-dividend stock is not entitled to the payment: 

(a) Next dividend. 

(b) Current divided. 

(c) Past dividend. 

(d) None of the above.

Ans: (a) Next dividend.  

5. Paying dividend is. 

(a) Not an expenses. 

(b) The division of an asset. 

(c) An inflows of funds. 

(d) All of the above. 

Ans: (b) The division of an asset. 

6. A is a payment of additional shares to shareholders in lieu of cash. 

(a) Split dividend. 

(b) Stock dividend. 

(c) Regular dividend. 

(d) Extra dividend.

Ans: (b) Stock dividend.   

A. Very Short Answer Questions: 

1. What do you understand about the financing decision? 

Ans: Financing decision is concerned with the procurement of funds, in an economic and prudent manner after judicious identification of timing and quantum of various sources of funds to be raised. Funds are available through primary market, financial institution and through the commercial banks. The cost associated with each of the instrument or source of funds is different. The overall cost of capital must be kept at minimum.

2. What do you understand by dividend decision? 

Ans: Dividend decision is concerned with taking decision with regards to the net profit distribution which is related either to pay dividend to shareholders or to retain in the business.

3. What do you understand by investment decision?

Ans: Investment decisions are influenced by cash flow by giving due care to time, value of money, risk involved, technological changes etc.To find out the viability of each capital expenditure decision,Capital budgeting, Cost-Volume-Profit analyses are the techniques generally used for the process of investment decisions. 

4. What is meant by financial planning? 

Ans: Financial planning is the process of identifying a firm’s investment and financing needs, given its growth objectives. Financial planning deals with framing of financial policies in relation to procurement of funds, investment of these funds and administration of funds of a business enterprise to achieve its objectives. 

5. State the components of working capital. 

Ans: (a) Current Assets A major component of working capital is current assets. A shortened definition of current assets is: a company’s cash plus its other resources that are expected to turn to cash within one year.

(b) Current Liabilities The other major component of working capital is current liabilities. A shortened definition of current liabilities is: a company’s obligations that will be due within one year. 

6. Describe the components of debt and equity. 

Ans: Debt Capital is a liability for the company that they have to pay back within a fixed tenure. Equity Capital is an asset for the company that they show in the books as the entity’s funds. Debt Capital is a short term loan for the organisation. Equity Capital is a relatively longer-term fund for the company.

7. Explain the importance of information signaling in dividend decision.

Ans: The important aspect of this decision is to determine how much amount of profit after tax is to be distributed to shareholders and how much amount is to be retained in the company for financing the growth and expansions of the business. Dividend announcements convey information to investors regarding the company’s future prospects. Suppose, if a company declared very high dividends, it gives a signal to prospective and present investors that the company has no future investment opportunities and vice-versa which decreases or increases the market price of the share. It is due to the information content of dividends. 

B. Short Answer Questions:

1. Critically examine the objective of financial management. 

Ans: The key objectives of financial management are: 

(i) Profit Maximization: A business firm is an organization established for the primary purpose of making profit for its owner. Generally, profit maximization is regarded as the prime objective of the business.

(ii) Wealth Maximization and Value Maximization: It is commonly understood that the basic objective of a business is to maximize wealth which lies in maximization of the

value of shares held by owners as they are the contributors to initial capital. For achieving this objective, the financial manager allocates the funds in assets and controls their use

taking time, value of time into consideration.

2. Explain the concept of working capital and its choice. 

Ans: Working capital is an amount used to serve the business on day-to-day basis fulfilling the requirement of everyday production and operation.Working capital can be increased by profitable business operation, sale of long-term assets, long-term borrowing and investment by owners. It can be decreased by unprofitable business operations; purchase of long-term assets without long-term financing, distributing cash to owners. 

Choice of the concepts depends upon the objective of the study. If the objective is to assess the efficiency of the business, then the gross concept of working capital will be suitable. But if the objective is to assess the liquidity position, then net concept will be suitable.

3. State the sources of fixed capital. 

Ans: (i) Issue of Share: It is the most important source of fixed capital. Generally, there are two types of shares as has been discussed in previous module. 

(a) Equity share. and 

(b) Preference share.

(ii) Issue of Right Shares: When a company decides to issue further share, it is first issued to its existing shareholders at a price below the market price. The share capital increases but the number of shareholders does not increase. Generally, rights issue is very economical to collect fixed capital. 

(iii) Private Placement of Shares: It means the company sells its shares directly to a small group of investors like bank, financial institutions, mutual funds etc. 

(iv) Issue of Debentures: It represents the borrowed capital of the company and holder of debenture gets interest on investment in debenture at predetermined stated rate. 

(v) Term Loans: The company gets term loans from banks and financial institutions like HDFC, ICICI etc by submitting its project analysis report. 

(vi) Retained Earnings: It is a part of undistributed profits earned by the company. This saved profit is called as ploughing back of profits.

(vii) Lease Financing: Under lease financing, lessor who is the owner of assets gives the assets on a lease-basis to the lessee and charges lease rent for using that assets. 

4. Explain capital structure and its components. 

Ans: The capital structure of a firm refers as a choice of that combination of debt and equity, which is used for financing the operations of business and to maximise the market value of the shares of the firm.

When a company is analysing what capital structure to adopt it can opt for: 

(i) Capital structure with equity shares only.

(ii) Capital structure with equity and preference shares.

(iii) Capital structure with equity shares and debentures.

(iv) Capital structure with equity, preference shares and debentures.

5. Explain the cost and risk associated with equity and debt capital. 

Ans: Debt and equity differ in cost and risk. Debt involves less cost as interest paid on debt is treated as a revenue expense and is subject to tax-shield, but it is risky because payment of regular interest on debt is a legal obligation for the business. In case the company fails to pay debt, debenture holders can claim over the assets of the company and if company fails to honour interest payment, it can even go to liquidation and stage of insolvency. 

Equity securities are safe securities from company’s point of view as company has no legal obligation to pay dividend to equity shareholders even if company is running on profit or loss but equity are expensive as payment of dividend is not subject to taxshield and their expectation of return is high as well as the company has no legal obligation to pay their capital contribution during the life of the company as they are owners.

6. State any four objectives of financial planning. 

Ans: The following aspects should be kept in mind so as to ensure the success of such an exercise in meeting the organizational objectives. 

(a) The plan must be simple: Now-a-days you have a large variety of securities that can be issued to raise capital from the financial market. But it is considered better to confine to owned funds (equity shares) and simple fixed interest-bearing finance (debentures and loans). 

(b) It must take a long-term view: While estimating the capital needs of a business and raising the required funds, a long-term view is to be taken into consideration which means that besides the need of ‘today’, the capital requirements of ‘tomorrow’ should also be kept in view. 

(c) It must be flexible: It is absolutely necessary that the financial plan must be capable of being adjusted and revised without any difficulty and delay so as to meet the future requirements of funds in changed business environment. Because no one may be able to properly visualise the possible developments in future. 

(d) It must ensure optimal use of funds: Whatever funds a business is raising, it has some cost which a firm has to pay to the provider of capital. Hence, capital should not be only adequate but should also be employed in a productive way and there should be proper balance between fixed capital and working capital. 

7. Explain the different modes of dividend payments. 

Ans: Here are the dividend payments modes:

(i) Cash Dividends: When a company shares a portion of its net earnings with its shareholders in the form of cash, we call it cash dividend. 

(b) Stock Dividend: It is also known as bonus shares. A dividend can be paid out in the form of shares of stock. Under the stock dividend issue, the company issues additional shares in a ratio to the investor’s current holding.

(c) Stock Repurchase: Under this type of dividend, the existing shareholder gets an option to sell his shares back to the company at a fixed rate. Generally, the fixed rate is higher than the prevailing market rate. 

8. Differentiate between fixed capital and working capital. 

Ans:

9. Distinguish between capital structure and financial structure. 

Ans:

C. Long Answer Questions:

1. What is meant by ‘Financial Planning’? Explain any four requisites of a sound financial plan. 

Ans: Financial planning is the process of identifying a firm’s investment and financing needs, given its growth objectives. It is a trade-off between various investment options and financing option. Financial planning deals with framing of financial policies in relation to procurement of funds, investment of these funds and administration of funds of a business enterprise to achieve its objectives.

The four requisites of a sound financial plan are:

(a) The plan must be simple: Now-a-days you have a large variety of securities that can be issued to raise capital from the financial market. But it is considered better to confine to owned funds (equity shares) and simple fixed interest-bearing finance (debentures and loans). 

(b) It must take a long-term view: While estimating the capital needs of a business and raising the required funds, a long-term view is to be taken into consideration which means that besides the need of ‘today’, the capital requirements of ‘tomorrow’ should also be kept in view. It ensures that the plan fully provides for meeting the capital requirement on long term basis and takes care of the changes in capital requirement from year to year. 

(c) It must be flexible: It is absolutely necessary that the financial plan must be capable of being adjusted and revised without any difficulty and delay so as to meet the future requirements of funds in changed business environment. Because no one may be able to properly visualise the possible developments in future. Not only that, the firm may also change its plans of expansion for various reasons. 

(d) It must ensure optimal use of funds: Whatever funds a business is raising, it has some cost which a firm has to pay to the provider of capital. Hence, capital should not be only adequate but should also be employed in a productive way and there should be proper balance between fixed capital and working capital. There should not be idle funds otherwise the profitability will decline. 

2. How does raising of long term funds through debt affect the return on shareholders’ funds? Explain with an example. 

Ans: Dividend constitutes the use of company’s funds. Dividends are payments made by a company to its shareholder members. It is the portion of profits paid out to stockholders. Paying dividends is not an expense; rather, it is the division of an asset among shareholders.The amount of the dividend is determined every year at the company’s annual general meeting, and declared as either a cash amount or a percentage of the company’s profit. Once declared, a dividend becomes a liability of the firm. A high dividend yield is considered to be evidence that a stock is underpriced, whereas a low dividend yield is considered evidence that the stock is overpriced. Holders of preference share get their regular dividend payment at fixed rate on the amount invested in the company out of profit but holders of equity share have no guarantee to receive dividend in spite of profit because it is the discretionary power of Board of Directors either to pay or not to pay any dividend; equity shareholders can’t claim dividend.

3. What is meant by ‘dividend’? State the factors that affect dividend decision. 

Ans: Dividend constitutes the use of company’s funds. Dividends are payments made by a company to its shareholder members. It is the portion of profits paid out to stockholders. Paying dividends is not an expense; rather, it is the division of an asset among shareholders.The amount of the dividend is determined every year at the company’s annual general meeting, and declared as either a cash amount or a percentage of the company’s profit.

There are three main factors that may influence a company’s dividend decision: 

(a) Free-cash Flow: The Company simply pays out, as dividends, any cash that is surplus after it invests in all available positive net present value projects. 

(b) Dividend Clientele: A particular pattern of dividend payments may suit one type of shareholder more than another. A retiree investor may prefer to invest in a company that provides a consistently high dividend yield, whereas a person with a high income bracket from employment may prefer to avoid dividends due to their high marginal tax rate on income. Although, dividend income received from an Indian company is exempt in the hands of shareholders either paid in the form of cash or bonus share until and unless sold out. If clientele exists for particular patterns of dividend payments, a company may be able to maximise its share price and minimise its cost of capital by catering to a particular clientele. Thus, this may lead to payment of relatively consistent dividend. 

(c) Information Signalling: Dividend announcements convey information to investors regarding the company’s future prospects. Suppose, if a company declared very high dividends, it gives a signal to prospective and present investors that the company has no future investment opportunities and vice-versa which decreases or increases the market price of the share. It is due to the information content of dividends. 

4. How do you assess the amount of working capital required by a business unit? Describe in brief. 

Ans: A wide variety of factors influence the total investment in working capital in an enterprise. Significant among them are: 

(a) Promotional and Formative Phase: The start-up of a new project and initial years constitute the most crucial phase for planning and provisioning of working capital funds. 

(b) Position of Business Cycle: Movements of the business cycle bring about shifts in working capital position. The upward swing is associated with spurt in sales and increase in levels of inventories and book debts. On the other hand, when there is a downswing, the levels of inventories and book debts may fall, causing cash flux. 

(c) Nature of Business: The nature of business has an important bearing on its working capital needs. For some ventures, such as retail stores, tobacco manufacture, construction companies, etc., the fixed assets become nominal or incidental and they require an abundance of working capital. 

(d) The Manufacturing Cycle: An extended time span, between the raw material purchase and the completion of the manufacturing process yielding the finished product, will obviously mean a larger tie-up of funds in the form of enhanced working capital needs. 

(e) Credit Terms to Customers: The credit terms granted to customers influence the working capital level by determining the level of investment in book debts. Liberal credit and Slack collection procedures or permissive attitude in the matter of collection of outstanding can also lock up funds that would otherwise be available for operating needs. 

(f) Vagaries in Supply of Raw Materials: Some raw materials may be available only in certain seasons so that these have to be obtained and stored, in advance, for the lean months. The working capital requirements, in such circumstances, will register seasonal fluctuations. 

(g) Shift in Demand for Products: The rising stock levels during the periods of production in excess of demand will require increasing amounts of working capital to be provided and these funds will remain, tied-up in inventories for some months. The financial planning will have to incorporate this pattern of funds requirements associated with steady production and seasonal sales. 

(h) Production Policies: A strategy of steady rate of production policy being maintained throughout the year as against a pronounced seasonal demand for manufactured goods is considered threat to the business. The problem is of finding funds to support the mounting inventory levels of finished goods until they get offloaded in the peak season. 

(i) Competitive Conditions: The degree of competition is an important factor influencing working capital requirements. To win and retain customers it will also be necessary to extend generous credit terms, in keeping with competitor’s practices, with very limited discretion in formulating own credit policies. The investment in book debts will, therefore, be of a high order requiring additional funds. 

(j) Growth and Expansion Programmes: As business grows, additional working capital has to be found. There is no simple formula to establish the link between growth in sales and growth in working capital or current assets. 

(k) Profit Level: By the very nature of things, some enterprises generate high gross margins, compared to others. High gross margins improve prospects of a higher rate of internal generation at the completion of each cash cycle which is based on the assumption that the benefit of high gross margin is not lost or dissipated in expensive enterprise activities in marketing and administrative areas. 

(l) Taxation: Tax liability is an inescapable element in working capital planning. It is a short-term liability payable in cash. Advance tax may have to be remitted in instalments, the computation being based on projected profits for the year. Periods of high taxation impose additional strain on working capital. The finance manager, who is well informed in tax matters, has appreciable scope for tax planning with a view-to reducing the cash drain by way of tax. 

(m) Dividend Policy: Dividend, once declared, is a short-term liability, leading to a cash outgo. There are statutory regulations governing prompt disbursements of dividends due and payable. 

(n) Depreciation Policy: Depreciation policy centres around the determination of the amount to be provided as depreciation charges to make up the ultimate resource for replacement of worn out or obsolete assets. The selection of the method of depreciation has important financial implications. If current capital expenditure falls short of the depreciation provision, working capital position is strengthened and there may be no need for short-term borrowing. 

(o) Reserve Policy: One of the cherished goals of enterprise management is to build up adequate reserves out of profits. Wherever the desire to build up reserves is dominant, working capital or funds position receives priority of consideration and dividends get a residual treatment. 

(p) Price Level Changes: It is also called as inflation. It is true that not all prices move at the same pace. Nor do they all move in the same direction. This diversity in price changes creates contradictions. It leaves some companies relieved of their working capital problems and, at the same time, it aggravates or intensifies the working capital problems of others. 

(q) Operating Efficiency: There is an obvious relationship between the operating efficiency of a company and its working capital position. Efficiency of operations accelerates the pace of the cash cycle, and improves the working capital turnover. It releases the pressure on working capital by improving profitability and aiding added internal generation of funds.  

5. “Financial management is much more than mere procurement of funds.” Explain. 

Ans: Financial management is concerned mainly with the procurement of funds in an economic and prudent manner and deploying these funds in most profitable way in a given risk situation, planning future operations and controlling current and future performance and development through different tools.In other words, financial management is basically concerned with mainly three decisions, namely, investment decision, financing decision and dividend decision. Financing decision is concerned with the procurement of funds, in an economic and prudent manner after judicious identification of timing and quantum of various sources of funds to be raised. Funds are available through primary market, financial institution and through the commercial banks. The cost associated with each of the instrument or source of funds is different. The overall cost of capital must be kept at minimum. Proper Debt/Equity ratio should be maintained to maximise the returns to the shareholders. This decision will be made by considering the different factors Viz., inflation, size of the organisation, Government policies, etc. In this way, decision criteria in financing.

6. What is meant by the term ‘leverage’? State the different types of leverages.

Ans: The word ‘leverage’ has been derived from the word ‘lever’ which refers to a device through which you can lift more weight with minimum efforts. Leverage refers to the capacity of a firm to employ more debt in the capital structure of the firm to maximize the EPS and to enhance returns to the owner as the cost of obtaining debt is cheap as compared to equity and minimize the cost of capital. That’s why every firm tries to minimize cost of capital by incorporating more and more debt in its capital structure.

It can be classified into three categories: 

(a) Financial Leverage: If you can envision a balance sheet of a company, financial leverage refers to the left-hand side of the balance sheet. Financial leverage refers to how the firm will pay for it or how the operation will be financed. Financial Leverage: refers to the amount of debt in the capital structure of the business firm.This measures the financial risk which arises due to high charge of interest due to excessive use of debt component.It is the company’s ability to use fixed financial changes to magnify the effect of changes in EBIT on the company’s EPS.A high financial leverage indicates a higher percentage of debt in the capital structure. It magnifies the returns from our debt financing. 

Financial Leverage= Earnings before interest and tax (EBIT)/ earnings before taxEBIT.

(b) Operating Leverage: There are essentially two types of costs in a company’s cost structure – fixed costs and variable costs. Operating leverage is the ratio of fixed costs to variable costs. If a business firm has a lot of fixed costs as compared to variable costs, then the firm is said to expose to operating leverage which measures the business risk or operating risk, i.e., variability of EBIT due to fluctuation in sales revenue. It means that if a firm has high operating leverage, a small change in sales volume results in a large change in Earnings before Interest and Tax and Return on Invested Capital.It magnifies the returns from our plant and equipment or fixed assets. Operating Leverage= Contribution/ Earnings before interest and tax (EBIT). 

(c) Combined Leverage: It indicates the effect of sales volume on the EPS of the firm.It is the relationship between Contribution and EBT. A higher combined leverage indicates the firm is subject to greater risk which includes both business risk and financial risk. It can be also found out by multiplying operating leverage and financial leverage. 

Combined Leverage = Contribution/EBT 

or 

Combined Leverage = Financial leverage × operating leverage.