What is degree of operating leverage and how can it be used for determining the capital structure?
Answers
Degree of operating leverage or DOL is basically the numerical measure of firm’s operating leverage. Practically, it is the sensitivity of EBIT (Earnings before taxes and interest) to changes in unit sales. And the operating leverage mainly deals with the relationship between the firm’s capital and its EBIT.
Mathematically,
DOL = percentage changes in EBIT/ percentage changes in sales
As long as the Degree of Operating Leverage is more than unity, there is operating leverage otherwise not.
Degree of operating leverage will let you to gauge the business risks in companies.
The financial leverage is used to determine the capital structure of a firm.
The higher is the amount of fixed charges to the total financial charges in the capital structure, the higher would be the financial leverage.
This is used to measure the financial risk in the firm.