

Financial leverage is the degree to which a company uses fixedincome securities such as debt and preferred equity. The more debt financing a company uses, the higher its financial leverage. A high degree of financial leverage means high interest payments, which negatively affect the company's bottomline earnings per share.
Financial risk is the risk to the stockholders that is caused by an increase in debt and preferred equities in a company's capital structure. As a company increases debt and preferred equities, interest payments increase, reducing EPS. As a result, risk to stockholder return is increased. A company should keep its optimal capital structure in mind when making financing decisions to ensure any increases in debt and preferred equity increase the value of the company. (Learn more about leverage in ETFs: Losing At Leverage and 5 Ways Debt Can Make You Money.)
Degree of Financial Leverage
The formula for calculating a company's degree of financial leverage (DFL) measures the percentage change in earnings per share over the percentage change in EBIT. DFL is the measure of the sensitivity of EPS to changes in EBIT as a result of changes in debt.
Formula:
DFL = percentage change in EPS or EBIT
percentage change in EBIT EBITinterest
A shortcut to keep in mind with DFL is that if interest is 0, then the DLF will be equal to 1.
Example: Degree of Financial Leverage
With Newco's current production, its sales are $7 million annually. The company's variable costs of sales are 40% of sales, and its fixed costs are $2.4 million. The company's annual interest expense is $100,000. If we increase Newco's EBIT by 20%, how much will the company's EPS increase?
Calculation and Answer:
The company's DFL is calculated as follows:
DFL = ($7,000,000$2,800,000$2,400,000)/($7,000,000$2,800,000$2,400,000$100,000)
DFL = $1,800,000/$1,700,000 = 1.058
Given the company's 20% increase in EBIT, the DFL indicates EPS will increase 21.2%. (For further reading, see Will Corporate Debt Drag Your Stock Down?)

Investing
Calculating Degree of Financial Leverage
Degree of financial leverage (DFL) is a metric that measures the sensitivity of a companyâ€™s operating income due to changes in its capital structure. 
Investing
Operating Leverage Captures Relationships
Find out how fixed and variable costs interact to shed new light on old companies. 
Investing
The Operating Leverage And DOL
Operating leverage tells investors about the relationship between a company's fixed and variable costs. The higher a company's fixed costs in relation to its variable costs, the greater its operating ... 
Managing Wealth
Leveraging Leverage For Bigger Profits
Leverage is like fire. Find out how to use it to heat up your investing without burning your portfolio. 
Investing
Leverage: Is It Good for Your Portfolio?
Discover the concept of financial leverage. Learn multiple ways to get leverage in your portfolio, and decide if leverage is a good idea for you. 
Trading
The Basics of Forex Leveraging
A closer look at the controversial topic of leverage in forex trading. 
Investing
4 Leverage Ratios Used In Evaluating Energy Firms
Analysts use specific leverage ratios to compare firms within an industry. A basic understanding of these ratios helps when evaluating oil and gas stocks. 
Investing
UPS Stock: Capital Structure Analysis
Analyze UPS' capital structure to determine the relative importance of debt and equity financing. Identify the factors influencing financial leverage trends. 
Financial Advisor
Understanding The Leverage Ratio
Learn more on how the leverage ratio is used to calculate a company's ability to meet financial obligations and how changes in output will affect operating income.