This degree of financial leverage ratio calculator measures the proportion of the earnings before interest and taxes against the earnings before taxes which shows the debt amount that a business is obligated to pay back. Below the form you can find the formula used.
How does this degree of financial leverage ratio calculator work?
The formula used by this degree of financial leverage ratio calculator is explained below:
DFL = Earnings before interest and taxes / Earnings before taxes
This financial indicator is usually used to:
- Measure the amount of debt a business has to repay;
- Determine the relative change in the net income in case of an increase/decrease of the interest rate on the debts (even the principal to be repaid is unchanged), as a change in the interest rates will have an impact on the expenses with the interest paid which in accounting is considered a fixed cost;
- Simulate what the level of the net income of a company will be by considering specific changes on its operating income, interest rates or the principal/debt left to be repaid;
- Study competitors within a specific market by comparing their levels of degree of financial leverage and see which ones have a riskier financial approach considering their capital structures.
The interpretation of the degree of financial leverage ratio level
The degree of financial leverage (DFL) is practically a measure of the degree of financial risk, thus the higher the ratio is the more risky the business is considered to be as it relies too much on debts and any changes within the economic environment or in interest rates may have an extremely negative impact on how the business evolves. This indicator is especially measured and assessed in case of companies that are listed on the stock exchange market.
Example of DFL ratio calculation
Let’s assume that a stock exchange listed company has the following situation:
- Earnings before interest and taxes = $100,000
- Earnings before taxes = $50,000
In this case the DFL ratio is $100,000 / $75,000 is 1.33 (or 133.33%).29 Apr, 2015