Degree of total leverage definition
/What is the Degree of Total Leverage?
The degree of total leverage is the proportional change in earnings per share that are associated with a given change in revenues. It is a combination of the degree of operating leverage and the degree of financial leverage. When a company has a large amount of operating and financial leverage, even a modest change in its sales can trigger a substantial change in its profitability.
How to Calculate the Degree of Total Leverage
The degree of total leverage can be calculated by dividing the percentage change in earnings per share by the percentage change in sales. The formula is as follows:
Percentage change in earnings per share ÷ Percentage change in sales = Degree of total leverage
How to Interpret the Degree of Total Leverage
A high degree of total leverage indicates that a business has both high operating leverage and high financial leverage. This means that its earnings per share can change dramatically as its sales change; this level of volatility also means that the business is at greater risk of failure, since a drop in sales may obliterate its earnings.
Conversely, a low degree of total leverage indicates that a business has relatively few fixed costs, which makes it less sensitive to changes in sales. These organizations tend to be more stable, but also have a lower earnings upside when their sales increase.
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FAQs
How is the Degree of Total Leverage Different from Operating Leverage?
The degree of operating leverage measures how sensitive operating income is to changes in sales, based solely on fixed operating costs. The degree of total leverage, on the other hand, combines both operating and financial leverage to show how sensitive earnings per share are to changes in sales. Thus, the degree of total leverage provides a more comprehensive view of risk by including the impact of both operating and financing decisions.