Leverage

Leverage is the percentage change in the wealth of the company for a given percentage change in sales. If a 10% increase in sales produces a 20% increase in EBITDA, the company is leveraged at a rate of 2 to 1. If the same 10% rate of growth of sales produces 10% change in EBITDA the company is not leveraged. The proportion of fixed costs relative to variable costs determines leverage. If all the costs are variable the company is not leveraged and a change in the rate of growth in sales will produce the same change in the rate of growth of EBITDA.

The two most important fixed costs that we can measure from the accounting numbers are SG&A expenses and interest costs. Interest costs are often considered to be the more risky of the two since the company is obligated to pay those expenses or face bankruptcy. SG&A (selling, general and administrative) expenses such as marketing, new product development, research and corporate overhead expenses are only theoretically fixed. Many company when under serious growth pressure will reduce SG&A to protect EBITDA growth.

Leverage will change over time. As the company grows sales, the proportion of fixed vs. variable costs will fall and the company will become less leveraged

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