DOL & DFL Can Be Less than One, Zero, Indeterminate or Even Negative

Abstract

‘Business risk’ and ‘financial risk’ are two significant terms in the literature of risk management of modern businesses in the era of stiff competition. Business risk is related with the investment decision and financial risk is related with the financing decision of the finance manager. These risks, if significant, may lead to financial sickness, even closure of a business, if they are ignored. In this context, degree of operating leverage (DOL) and degree of financial leverage (DFL) are two universally recognized measures of operating and financial risks of any business organisation. Their joint impact can also be calculated by degree of total leverage (DTL) to assess the combined or total risk. The present paper aims at highlighting some irregularities of the established theories on the measures mentioned above and suggests a few alternatives to assess business, financial and combined risks associated with a business enterprise. It is said that DOL and DFL can be greater than or equal to 1; but, this paper shows that these two measures can be less than one, or zero, or indeterminate or even negative. It also seeks to identify certain alternative measures to overcome the limitations of these age-old parameters of business, financial and total risks.