## Degrees of Leverage – DOL, DFL, and DCL
### Operating Risk vs Financial Risk
| Basis | Operating Risk | Financial Risk |
|---|---|---|
| Meaning | Cannot cover fixed operating costs | Cannot meet fixed financial charges |
| Cause | Fixed operating costs (rent, depreciation, salaries) | Fixed financial costs (interest, preference dividend) |
| Impact | Variability in EBIT | Variability in EPS |
| Measured By | DOL (Degree of Operating Leverage) | DFL (Degree of Financial Leverage) |
| Level Depends On | Proportion of fixed operating costs in total costs | Proportion of debt/preference in capital structure |
| Higher Means | EBIT more sensitive to sales changes | EPS more sensitive to EBIT changes |
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### Range of DOL, DFL, and DCL
#### Degree of Operating Leverage (DOL)
| Situation | DOL Value |
|---|---|
| Zero sales | 0 |
| At BEP (EBIT = 0) | ∞ (infinity) |
| Sales > BEP | Positive and > 1 |
| Sales < BEP | Negative |
> DOL = % Change in EBIT / % Change in Sales
#### Degree of Financial Leverage (DFL)
| Situation | DFL Value |
|---|---|
| No fixed financial charges | 1 (no amplification) |
| EBIT = Interest | ∞ (infinity) |
| EBIT > Interest | Positive and > 1 |
| EBIT < Interest | Negative (< 0) |
> Critical Rule: DFL can NEVER be between 0 and 1. It is either ≤ 0 or ≥ 1.
> DFL = % Change in EPS / % Change in EBIT
#### Degree of Combined Leverage (DCL)
| Situation | DCL Value |
|---|---|
| No fixed operating AND financial costs | 1 |
| Sales = BEP or EBIT = Interest | ∞ |
| Sales > BEP AND EBIT > Interest | Positive and > 1 |
| Sales < BEP or EBIT < Interest | Negative (< 0) |
> DCL = DOL × DFL = % Change in EPS / % Change in Sales
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### Analysis of Financial Leverage Situations
| Situation | Result |
|---|---|
| No fixed financial cost | No financial leverage (DFL = 1) |
| Higher fixed financial cost | Higher financial leverage |
| EBIT > Financial break-even | Positive financial leverage |
| EBIT < Financial break-even | Negative financial leverage |