Quick Finance Tip – Financial Risk and Degree of Financial Leverage

​Financial risk is associated with how a company finances its operations, and the more fixed costs of financial obligations (i.e. debt), greater the financial risk. Degree of Financial Leverage (DFL) is the change in income divided by the change in operating income.
 
Formula: DFL = (CM – F)/ (CM – F – C); where CM = Contribution Margin which equals Quantity * (Price - Variable Operating Unit Cost); F = Fixed Operating Costs, and C = Fixed Financial Costs
 
Financial leverage is most often a choice (unlike operating leverage). Using financial leverage generally increases Return on Equity, and usage by a profitable company may increase ROE levels.