The Degree of Combined Leverage (DCL) is a financial metric that measures the sensitivity of a company’s earnings per share (EPS) to changes in its sales. It combines both the operating leverage and financial leverage of a company to provide a comprehensive view of how changes in sales impact its bottom line, specifically its EPS.

The formula for calculating the Degree of Combined Leverage is as follows:

\[ \text{Degree of Combined Leverage (DCL)} = \text{Degree of Operating Leverage (DOL)} \times \text{Degree of Financial Leverage (DFL)} \]

The components of the formula are:

– **Degree of Operating Leverage (DOL):** Measures the sensitivity of operating income (EBIT) to changes in sales.

– **Degree of Financial Leverage (DFL):** Measures the sensitivity of earnings per share (EPS) to changes in operating income.

Key points about the Degree of Combined Leverage:

1. **Interpretation:**
– The Degree of Combined Leverage indicates how much the earnings per share (EPS) of a company will change in response to a given percentage change in sales. It combines the impact of both operating and financial leverage.

2. **Operating Leverage vs. Financial Leverage:**
– Operating leverage is related to the company’s cost structure, while financial leverage is related to the capital structure. DCL integrates both aspects to provide a more holistic view of a company’s leverage.

3. **Amplifying Effects:**
– DCL has an amplifying effect on the impact of sales changes on EPS. When both operating and financial leverage are high, small changes in sales can lead to proportionately larger changes in EPS.

4. **Risk and Volatility:**
– Companies with high DCL are generally more exposed to risk and volatility. While high DCL can amplify profits in a growing market, it can also magnify losses in a declining market.

5. **Investor Considerations:**
– Investors may consider DCL when assessing a company’s risk profile and potential impact of changes in sales on its profitability. Companies with lower DCL may have a more stable EPS in the face of sales fluctuations.

6. **Comparison and Analysis:**
– DCL can be used to compare companies within the same industry or assess the impact of changes in sales on a specific company over time. It is a useful tool for financial analysis and forecasting.

7. **Limitations:**
– DCL assumes that the relationship between sales, operating income, and EPS remains constant, which may not always be the case in dynamic business environments.

Understanding the Degree of Combined Leverage is important for financial analysts, investors, and management to assess the overall impact of sales changes on a company’s profitability and shareholder returns. It provides insights into how the company’s cost and capital structures interact to influence its financial performance.