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.