Applying Operating and Economic Leverage in Consulting Company

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Financial Leverage

After the 34% tax Net Income is $692,000. If EBIT increases by 20% the Net Income increases by 23%.

Loan ; $1,000,000 ; ; ; ; ; ;Interest rate ;10% ; ; ; ; ; ;Tax rate ;34%

EBIT ; ;$1,200,000 ; Interest ;$(100,000) ; Tax ; ;$(408,000) ; Net Income ;$692,000

20% increase in EBIT; EBIT ; ; $1,440,000 ; ; Interest $(100,000) Tax ; ; ; $(489,600) ; ; Net Income; ; $850,400

40% increase in EBIT; EBIT ; ; $1,680,000 Interest $(100,000) Tax ; ; $(571,200) Net Income ; $1,008,800

60% increase in EBITEBIT ; ; $1,920,000 Interest ; ; ; $(100,000)Tax ; ; $(652,800)Net Income $1,167,200

Operating Leverage

The ratio of fixed cost (FC) to total costs (TC) is called operating leverage. So if the company can utilize 10 consultants. If Fixed costs were $25,000 the net income would be $115,000 (for 10 consultants) and $205,000 (for 20 consultants), i.e. 78% increase in Net Income.

Revenue: $120,000 VC ; : $(30,000)FC ; : $(50,000) NI :$40,000

Revenue: $240,000 VC ; : $(60,000)FC ; : $(50,000) NI :$130,000

Change in #Consultants ; Change in Net Income 100% 225%200% 450%300% 675%