## Important Terms / Concepts used in Leverages

### A. Types of Fixed Cost

Fixed costs split into two:

```

Fixed Cost

/ \

Fixed Operating Cost Fixed Financial Cost

(Salary, Factory Rent) (Interest on Debt,

Preference Dividend)

```

Rule: If the question is silent, assume the fixed cost is a Fixed Operating Cost.

### B. Marginal Costing Terminologies

Variable Costs — costs that vary with sales.
Contribution = Sales − Variable Cost.
Profit Volume Ratio (PVR) = (Contribution ÷ Sales) × 100.
Break-Even Point (BEP) — volume where EBIT = 0 (total operating cost = total sales revenue).

$$BEP\,(units) = \frac{Fixed\ Cost}{Contribution\ per\ unit}$$

### C. Ratios used in numerical problems

Ratio	Formula
EPS	EFE ÷ No. of Equity Shares
ROE	EFE ÷ Equity Shareholders' Fund*
PE Ratio	MPS ÷ EPS
Earnings Yield (Earnings Price)	EPS ÷ MPS (inverse of PE)
Total Asset Turnover	Sales ÷ Total Assets
ROCE / ROI	EBIT ÷ Capital Employed (or EBIT(1−T) ÷ Capital Employed)
Interest Coverage	EBIT ÷ Interest
Preference Dividend Coverage	EAT ÷ Preference Dividend
Equity Dividend Coverage	EFE ÷ Equity Dividend
Operating Profit Ratio	(EBIT ÷ Sales) × 100

*Equity Shareholders' Fund = Equity Share Capital + Reserves and Surplus.

Capital Employed = Equity + Retained Earnings + Preference Share Capital + Debentures + Long-Term Liabilities.

(EFE = Earnings for Equity / Net earnings available to equity shareholders.)

Worked example

### Example 1

BEP and MOS: Fixed cost ₹2,00,000; selling price ₹50/unit; variable cost ₹30/unit.

Contribution per unit = 50 − 30 = ₹20.

BEP (units) = 2,00,000 ÷ 20 = 10,000 units.

If actual sales = 15,000 units, MOS = 15,000 − 10,000 = 5,000 units.

### Example 2

Interest Coverage Ratio: EBIT ₹6,00,000, Interest ₹1,50,000.

Interest Coverage = 6,00,000 ÷ 1,50,000 = 4 times.

⚠️ Common exam mistakes

Treating a silent fixed cost as financial cost — default assumption is fixed OPERATING cost.
Confusing PE ratio (MPS/EPS) with earnings yield (EPS/MPS), which are reciprocals.
Using EBIT instead of EAT in the Preference Dividend Coverage Ratio.
Omitting Reserves and Surplus when computing Equity Shareholders' Fund for ROE.
Forgetting that BEP is the point where EBIT = 0, not where net profit = 0.

Reference:

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Key Terms used in Leverages (Fixed Cost, Marginal Costing & Ratios)

Worked example