How degree of financial leverage works

Degree of financial leverage asks how hard a change in operating profit moves the residual after the coupon:

$$DFL = \frac{\text{EBIT}}{\text{EBIT} - \text{Interest}}$$

On $80,000,000 of EBIT against $10,000,000 of interest, the residual is $70,000,000. DFL is $80 / 70 = 8/7$, which prints as 1.14. Interest coverage on the same sheet is 8 times. The two are one identity: $DFL = \text{coverage} / (\text{coverage} - 1)$.

A 1 percent rise in EBIT, holding the bill still, is a 1.14 percent rise in pre-tax profit. The coupon does not come along for the ride, so the residual moves harder than EBIT.

The interest coverage calculator on this page is that pair. The DFL explorer holds the bill still and lets you drag EBIT. Watch DFL fall toward 1 as coverage rises.

Coverage against DFL is the multiple against the multiplier. DOL against DFL is a cost-base multiplier against this coupon multiplier. They do not share a teaching sheet.

DFL is 1.14 because the leftover after the coupon is $70,000,000. How the interest residual works owns that $70,000,000. This page owns the 8/7 multiplier.

Keep EBIT at $80,000,000. Raise interest to $20,000,000. Coverage falls to 4 times. The residual is now $60,000,000. DFL is $80 / 60 = 4/3$, which prints as 1.33.

Profit did not fall. The bill did. The multiplier rose because the residual thinned. That is the rate-reset case in one line. Floating-rate debt that rolls into a higher coupon does this without any new borrowing. The leverage ratios on the balance sheet may not have moved at all.

EBIT $40,000,000, interest still $10,000,000. Coverage is 4 times, matching the second sheet. Residual $30,000,000. DFL is $40 / 30 = 4/3$, 1.33 again.

Same coverage, same DFL. The first sheet cut the denominator. This one cut the numerator. Degree of financial leverage is a function of coverage. It does not know whether the multiple fell because the coupon rose or because the year got worse.

When EBIT equals the interest bill, the residual is zero. Dividing by zero does not produce a cash multiplier anyone can spend. The formula is silent at that crossing, the way degree of operating leverage is silent at break-even.

Just above a coverage of 1, DFL is large. Further out it falls toward 1. A firm with no interest expense has nothing to multiply: DFL is not a number on a zero-coupon sheet, and this calculator will not print Infinity for coverage either.

Degree of operating leverage is contribution over EBIT, a cost-base fact. Degree of financial leverage is EBIT over EBIT minus interest, a coupon fact. Multiplying the two would combine them, and only on one firm with both sheets filled in. This page does not mash the break-even teaching sheet onto the coverage teaching sheet.

Operating against financial leverage is the cost base against the balance-sheet D/E. DOL against DFL is the two multipliers, on their own sheets.

It is not a covenant engine, not DOL, and not a claim that 1.14 is a target. The three sheets are DFL 1.14 on 8 times coverage ($80,000,000 over $10,000,000), DFL 1.33 on 4 times coverage after the bill doubles, and DFL 1.33 on 4 times coverage after EBIT halves. This is educational material, not financial advice.