Business Risk Ratios

Financial Ratios

    Business Risk Ratios

  •         The term business risk refers to the possibility of inadequate profits or even losses due to uncertainties e.g., changes in tastes, preferences of consumers, strikes, increased competition, change in government policy, obsolesce etc.

    Simple Method

    Contribution Margin Ratio

        The contribution margin as a percentage of total sales is called as contribution margin ratio.

    Contribution Margin Ratio = Contribution Margin/Sales = 1 - variable costs/sales.

    Operation Leverage Effect (OLE)

             It is used to measure how much revenue will change given a percentage change in sales volume.

       Operation leverage effect = contribution margin ratio/return on sales (ROS)

    Where:

    ROS = Percentage change in income (ROA) = OLE x % change in sales

    Financial Leverage Effect (FLE)

              It measures the amount of debt held by the business firm that they use to finance their operations.

    Financial leverage effect = operating income /net income

    Combined Leverage Ratio

        All the companies must calculate the operation leverage and financial leverage. By using the combined leverage the company can calculate the effect of both leverage.

    Combined Leverage Ratio = Operating Leverage Ratio X Financial Leverage Ratio.

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