the value of DTL. It is simply the ratio between the Contribution and the PBT as shown
below:
DOL = Contribution = 37519 = 4.93
PBT 7612
It is customary to break up this risk into two components: (i) the Degree of Operating
Leverage (DOL) arising from the structure of operating costs of the firm, (ii) the
Degree of Financial Leverage (DFL) arising from the capital structure of the firm.
The degree of operating leverage (DOL) measure the percentage change in EBIT for a
1% change in sales and is computed as follows:
DOL = Contribution = 37519 = 3.74
EBIT 7612 + 2428
The degree of financial leverage (DFL) on the other hand measures the percentage
change in PBT for a 1% change in EBIT and is computed as follows:
DOL = EBIT = 7612 + 2428 = 1.32
PBT 7612
The degree of total leverage (DTL) is nothing but the product of DOL and DFL.
DTL = DOL X DFL = 3.74 X 1.32 = 4.93
Let us try to understand as to why changes in sales have an amplified impact on the
profits. It is the presence of fixed costs of operations that cause a 1% change in sales to
result in more than 1% change in EBIT. Similarly, since interest is also a fixed cost a 1%
change in EBIT causes profits to change by more than 1%. The net effect is that the
fixed costs acting as levers magnify the impact of changes in sales on profits.
Accounting Policies and Notes.
All accounting statements are prepared using a set of accounting policies regarding
depreciation of fixed assets, valuation of inventory, recognition of income and other
similar matters. On many of these matters, companies do have the freedom to choose
between alternative accounting policies. For an investor, therefore, it is important to
understand these policies to interpret the accounting statements correctly. Companies in
India do not always disclose the complete details of all relevant accounting policies, but
the more important of these can be gleaned from the section entitled ‘Notes Forming Part
of the Accounts’ in the published annual report. These notes are often written in a style
which makes it difficult even for accountants to understand their true import, but any