Degree of Combined Leverage
Candlefocus EditorDegree of Combined Leverage (DCL) is an important financial analysis concept that helps companies understand the effects of their combined operating and financial leverage on their earnings per share. The formula takes into account all sources of financing, including both operating and financial leverage, and provides the company with information regarding how a change in its shares will change their earnings per share. It is especially useful for companies considering increased leverage for the purpose of improving their overall financial performance.
The DCL formula is simple, yet also very useful in financial analysis. It can measure the relative effect that a company's capital structure and operating performance will have on its EPS. To calculate the degree of combined leverage, the company multiplies its existing operating leverage by its existing financial leverage, which results in a combined leverage ratio.
Operating leverage is the ratio of a firm's fixed operating costs to its variable operating costs. It measures how much a company utilizes its fixed assets to generate more sales and revenues. Financial leverage measures the portion of a company's capital structure that is funded by borrowing. It is used to determine the effect that debt financing has on the company's total capital structure.
Together, the operating leverage and financial leverage ratios measure the amount of risk associated with the company's particular capital structure and operating performance. When combined, they serve as important indicators of a company's EPS.
The joint effect of operating and financial leverage ratios is known as the degree of combined leverage. To calculate it, the operating leverage ratio must first be determined, which is found by dividing the company’s fixed operating costs by its variable operating costs. The financial leverage ratio is determined by dividing a company's total long-term debt by its total shareholder’s equity.
When the DCL ratio is calculated, the company can then compare it to other companies in the industry and get a better insight into its competitive position. Moreover, companies can use the key formula to understand how the combined leverage will affect their bottom-line when they add or remove sources of financing. This particular information can help the company assess the level of risk it should take in order to boost its return on investment.
Overall, Degree of Combined Leverage is an important tool that companies can use to understand the full effects of their combined leverage on their earnings per share. With careful use of the formula and a thorough analysis of its components, companies can obtain insight into their capital structure and determine their best possible levels of operating and financial leverage.