Degree of Combined Leverage (DCL)
What Is the Degree of Combined Leverage (DCL)?
A degree of combined leverage (DCL) is a leverage ratio that sums up the combined effect that the degree of operating leverage (DOL) and the degree of financial leverage has on earnings per share (EPS), given a specific change in sales. This ratio can be utilized to assist with deciding the most optimal level of financial and operating leverage to use in any firm.
The Formula for the Degree of Combined Leverage Is
What Does the DCL Tell You?
This ratio sums up the effects of consolidating financial and operating leverage, and what effect this combination, or varieties of this combination, has on the corporation's earnings. While not all corporations utilize both operating and financial leverage, this formula can be utilized assuming they do.
A firm with a moderately high level of combined leverage is viewed as less secure than a firm with less combined leverage since high leverage means more fixed costs to the firm.
Degree of Operating Leverage
The degree of operating leverage measures the effects that operating leverage has on a company's [earnings potential](/procuring potential) and demonstrates how earnings are impacted by sales activity. The degree of operating leverage is calculated by partitioning the percentage change of a company's earnings before interest and taxes (EBIT) by the percentage change of its sales over a similar period.
Degree of Financial Leverage
The degree of financial leverage is calculated by separating the percentage change in a company's EPS by its percentage change in EBIT. The ratio demonstrates how a company's EPS is impacted by percentage changes in its EBIT. A higher degree of financial leverage demonstrates that the company has more unpredictable EPS.
Degree of Combined Leverage Example
As stated previously, the degree of combined leverage might be calculated by duplicating the degree of operating leverage by the degree of financial leverage. Expect speculative company SpaceRocket had an EBIT of $50 million for the current fiscal year and an EBIT of $40 million for the previous fiscal year, or a 25% increase year over year (YOY). SpaceRocket reported sales of $80 million for the current fiscal year and sales of $65 million for the previous fiscal year, a 23.08% increase.
Furthermore, SpaceRocket reported an EPS of $2.50 for the current fiscal year, and an EPS of $2 for the previous fiscal year, a 25% increase. SpaceRocket in this way had a degree of operating leverage of 1.08 and a degree of financial leverage of 1. Thus, SpaceRocket had a degree of combined leverage of 1.08. For each 1% change in SpaceRocket's sales, its EPS would change by 1.08%.
Highlights
- The DCL formula sums up the effects that the combined degree of operating leverage and degree of financial leverage have on a company's earnings for every share, in view of a given change in shares.
- The ratio assists a company with knowing its best potential levels of operational and financial leverage.
- The formula assists companies with understanding what the combined leverage means for the company's total earnings.
