Connect with us

Finance & Accounting

What Is DEGREE OF FINANCIAL LEVERAGE: Overview, Formular, Importance




Almost all business transactions require money, making prudent financial management an important part of running a business.

In this article, we will discuss the Degree of financial leverage, how to calculate DFL, the importance of leverage, and many more.

What is a degree of financial leverage (DFL)?

A degree of financial leverage (DFL) is a leverage ratio that measures the sensitivity of a company’s earnings per share (EPS) to fluctuations in operating profit as a result of changes in its capital structure. The degree of financial leverage (DFL) measures the percentage change in earnings per share for a change in operating profit, also known as earnings before interest and taxes (EBIT).

This relationship shows that the higher the level of financial leverage, the more volatile the returns. Since interest rates are usually a fixed expense, leverage increases returns and EPS. This is fine when operating profit is increasing, but can be a problem when operating profit is under pressure.

Financial Leverage

Financial leverage is the ratio of a company’s equity to financial debt. It is an important element of a company’s financial policy. Financial leverage can also mean using the company’s financial resources at a fixed price. A financial leverage of two implies that for one dollar of equity there is two dollars in financial debt. This enables the company to use debt to fund acquisitions of assets.

The concept of leverage is widely used in the business world. It is primarily used to increase the profitability of a company’s equity, especially when the company is unable to increase its operational efficiency and return on investment. Because loan yields are higher than the interest payable on debt, the overall profit of the company increases, and ultimately the profit for shareholders.

The leverage effect can be favorable or unfavorable. It is positive when the income is greater than the cost of the debt. However, it is negative when the company’s profits are less than the cost of insuring the funds. Leverage is an essential source of capital to support limited shareholder investments. It also helps you get the ideal return on equity.

Formula for DFL

The formula for the degree of financial leverage calculates the change in net income resulting from the change in the company’s earnings before interest and taxes. helps determine how sensitive the company’s profit will be to changes in the capital structure.

As can be seen from the formulas below, the level of financial leverage can only be calculated from the Profit and Loss Account. The DFL formula measures the change in net income when the operating result changes by 1% (which can also be referred to as earnings before interest and taxes or EBIT). The output of the DFL formula can be read as “for every 1% change in the operating result, the net result changes by X%”.

Although the formulas only talk about interest expenses, dividends on preferred capital must also be included, as this is the most common type of financing. When the company has preferred capital in its capital structure. If a company is profitable and has no funding other than equity, the DFL is equal to 1. In most cases, however, the DFL is always greater than 1, as debt and preferred equity financing are often used to leverage equity.


What does the level of financial leverage tell you?

The higher the DFL, the more volatile the earnings per share (EPS). Since interest is a fixed expense, leverage increases ROI and EPS, which is good when operating income is rising, but can be a problem during tough economic times when operating income is under pressure.

DFL is invaluable in helping a company assess how much debt or financial leverage to choose in its capital structure. If operating income is relatively stable, earnings and earnings per share would also be stable and the company can afford to take on significant debt. However, if the company is in an industry where operating results are quite volatile, it may be wise to keep debt levels down to manageable levels.

The use of financial levers varies greatly depending on the industry and industry. There are many industrial sectors in which companies operate with a high degree of financial leverage. Retail stores, airlines, supermarkets, utilities, and banking institutions are classic examples. Unfortunately, the excessive use of financial leverage by many companies in these sectors has played an important role in forcing many of them to file for Chapter 11 bankruptcy.

Degree of financial leverage vs Balance sheet financial leverage

While both the level of financial leverage calculated from the income statement and the most common financial leverage metric used on the balance sheet have to do with quantifying the risk to a company’s capital structure, it does so in two different ways and you can sometimes lead to conflicting results.

The differences arise because the interest rates on debt can vary widely between companies or industries, and the interest rates on debt can also change over time. The amount of financial leverage on the balance sheet may be the same, but if the interest rates are different, the amount of financial leverage will be different because interest expense is charged on the same dollar debt.

How to Measure the Effects of Leverage

The effect of leverage is measured by subtracting the economic rate of return after corporate tax is deducted from the return on equity. Since shareholders’ return on equity is typically higher than the economic performance ratio, leverage plays an important role in meeting investor expectations for return on equity. For this reason, the financial leverage is measured by how the additional debt affects earnings per common shareholder.

Importance of leverage

Leverage offers companies the following benefits:

  • Leverage is an essential tool that senior management can use to make the best funding and investment decisions.
  • It offers a variety of funding sources through which the company can achieve its targeted profits.
  • Leverage is also an important investment technique as it helps companies set a threshold for growing their business. For example, it can recommend limits on business expansion once the projected return on the additional investment is below the cost of debt.


Understanding a company’s level of financial leverage can enable an investor to assess the risk and return associated with its capital structure. Interest expenses are the most common type of financing. However, if the company has lease obligations or preferred stock in its capital structure, the related payments should also be included in the DFL calculation.


Click to comment

Leave a Reply

Your email address will not be published. Required fields are marked *

Finance & Accounting

BACK-TO-BACK LETTERS OF CREDIT Examples, Advantages and Alternatives




You probably have heard of the phrase “Back-to-Back Letters of Credit” and you really want to get in-depth knowledge about it but don’t know who to ask. Good thing you’re here. We have highlighted some important details about Back-to-Back Letters of Credit, how it works, advantages, and alternatives.

What are Back-to-Back Letters of Credit?

Back-to-back letters of credit are double letters of credits (LoC) used together to finance a transaction. A back-to-back letter of credit is often used in transactions involving intermediaries between buyers and sellers, such as sellers, or when the seller has to buy the goods he sells to the supplier as a number sold to buyers.

The backend loan consists of two separate LoCs, one issued by the buyer’s bank for the intermediary and one issued by the broker-dealer for the broker. With the original LC from the buyer’s bank, the broker goes to his bank and issues a second LC and the seller wins.

Thus, the seller is guaranteed payment when the contract expires and submits the relevant documents to the intermediary bank. In some cases, the seller may not even know who the end buyer is.

How Do Back-to-Back Letters of Credit Work?

A  letter of credit is a written promise from the bank that it will pay the seller (called the beneficiary) if the customer (the holder) does not.

For example, assume that Company A is a wholesaler. One of its customers, a large retailer, provides a note to Company A to assure Company A that it can pay for large orders of precious stones placed there.

To fulfill a large order, Company A has to buy a lot of raw materials from one of its suppliers. The supplier requests a certificate from Company A’s bank. Thanks to the receipt from the store, the Company A knows that it will receive a salary and can issue the certificate to the supplier.

Securities are more common in international stock exchanges when buyers or sellers do not know each other well or the laws and agreements that some stock exchanges may complicate.

Banks often require insurance or financial security to issue a certificate to their owner. Banks also charge fees and the cost is usually a percentage of the size of the account.

Customs and international trade service procedures for documentary credit govern the use of securities used in international transactions. In the United States, a foreign exchange trading code governs securities used in domestic stock exchanges.

Debit cards are often a negotiable tool, meaning that the lending bank must pay the beneficiary or any bank designated by the beneficiary.

In some cases, the credit card can also be transferred, which means that you have the right to give an advantage to the other company (such as a parent or even a third party).

Because the two letters are interconnected and interdependent, it is a reliable loan. It is important to note that future accounts overlap. That is, the mission, control and other conditions are the same. In this regard, the first debt letter becomes the guarantee of the second debt.

Advantages of Back-to-Back Letters of Credit

Back to back letters of credit are a smart, easy, and fast way to secure foreign exchange between the two countries. The original letter of credit was issued by the bank in the client’s name, while the other letter was from the broker who had the support of the bank itself. Here are some of the key benefits of a credit card loan.

  • Low Risks
  • Assurance and Success
  • Reliable

Low Risks: Future repayment loans reduce the pressure on all participants in the exchange from buyer to the seller. It is also a variety of guarantees that the payment will be made by the bank in case their customers do not meet the contract period.

Assurance and Success: Later loan applications are also effective and inexpensive as the bank takes care of the planning and other services for you. Customers can consult their dealers and market experts. You can even visit the bank’s website and read the notes, as they are a reliable source of information for users.

Reliable: With the banks supporting the exchange, the deal has become more reliable and secure for merchants who have to accept payment. Papers are often used as a last resort when there is bad debt to the buyer

READ ALSO: 5 quick bad debt recovery strategies

Alternatives to a Back-to-Back Letter of Credit

A Transferrable Letter of Credit

Once the invoice is issued, the transfer of one or part of the value of the loan to a third party or the so-called second beneficiary is allowed. In the example above, the beneficiary is a seller and is now able to transfer all or part of the value of the certificate to the actual manufacturer of the products and can do so unless he uses his own credit.

The lending bank, which is usually the lending bank or advisor, will primarily issue the transfer letter (TLC) and advise the second beneficiary. TLC will look like the original LC, with a few exceptions. If the original LC requires four documents – invoices, business invoices, package lists, and certificates of origin – the relocated LC contains the same documents and the same documents.

An Assignment of Proceeds

Suppose we have a buyer, a broker, and a supplier. At the request of the broker, a buyer requests a letter of credit, but this time there is no mention that the letter of credit must be transferable. The letter of credit is issued and sent to the advising bank, who in turn advises the beneficiary, also known as a broker or intermediary.

The beneficiary knows that his supplier wants some kind of guarantee that he will be paid, but the beneficiary wants to maintain maximum control over the transaction. An income transfer could be the answer.

Upon receipt of the letter of credit, the beneficiary would approach their bank with the original letter of credit in hand and request that a specific value of the original letter of credit is assigned to the provider. For example, if the LC was issued for $ 50,000, the allocation request could be $ 35,000.

The bank will require the original letter of credit to be submitted along with the written request for the assignment. The bank needs the original LC in order to support the back of the LC indicating that an allocation has been made to the designated party and the value of the allocation.

Remember, most letters of credit are freely negotiable, which means that the beneficiary can present documents to any bank. By endorsing the LC, any bank that may receive documents will know that an assignment has been made.

Once the endorsement has been attended, the bank will issue a document or letter entitled Assignment of Income addressed, in this case, to the provider. The content of this document will indicate that an income transfer has been made in your favor with a declared value. It will also indicate that if and when the payment is made according to the letter of credit, the payment will be made automatically according to the assignment.

Now that the supplier is withholding the Assignment of Revenue, you can be assured that they will receive payment and deliver the merchandise to the intermediary / beneficiary. If everything goes according to plan, the beneficiary organizes the shipment, obtains the necessary documents to draw against the LC, presents these documents to the bank and the bank makes the payment to both the beneficiary and the owner of the transfer of income.

Again, this may seem like the perfect solution for the buyer, broker / broker, and supplier, but could something go wrong with this approach? Unfortunately yes.

With Assignment in place, once the vendor delivers the merchandise to the broker / broker, the vendor loses control of the transaction. In the worst case, the supplier goes ahead and ships the goods to the buyer, but also contacts him to propose that he not use the LC as a payment method.

They might even suggest that instead of the LC, they would be happy to offer open account terms. They can propose that after the buyer has received the goods, they can make the payment by bank transfer.

The buyer, unaware that a revenue assignment has been issued, may be excited at the prospect of not having to pay their bank an LC examination fee and agree to the open account proposal.

Meanwhile, we have the provider sitting patiently waiting for payment. After two to three weeks, they may contact the bank to inquire about the status of the allowance payment only to learn that the documents against the letter of credit have not yet been submitted. The provider will be referred to the line in the income allocation in which the payment will be made if the payment is made according to the letter of credit.

The provider then tries to contact the broker/broker only to find that the phone has been disconnected and they appear to have left town. The provider’s payment outlook at the moment is not very good. For this same reason, suppliers or manufacturers can avoid this agreement


Back-to-Back Letters of Credit LCs essentially replace the debts of two banks that provide buyers and intermediaries and thus help facilitate exchanges between parties that may be far apart and may not be able to verify the individual debt.

RELATED: What are the Types of Brokers and Brokering Services?

Continue Reading

Finance & Accounting

What Is Strategic Financial Management?- Functions and Importance




What is Strategic Financial Management?

Strategic financial management means not only managing a company’s finances, but also with the intention of being successful – that is, achieving the company’s goals and objectives and maximizing shareholder value over time. However, before a company can strategically manage itself, it must first clearly define its goals, identify and quantify its available and potential resources, and devise a specific plan for using its finances and other capital resources to achieve its goals. .

Strategic financial management is about generating profits for the company and ensuring an acceptable return on investment (ROI). Financial management is accomplished through business financial plans, the establishment of financial controls, and the making of financial decisions.

Understanding of strategic financial management

Strategic financial management is about generating profits for the company and ensuring an acceptable return on investment (ROI). Financial management is achieved through financial business plans, established financial controls, and financial decisions.

Financial management itself requires knowing and properly managing, distributing and maintaining a company’s assets and liabilities, including overseeing the operational financial elements such as expenses, sales, accounts receivable and payable, cash flow and profitability.

Strategic financial management encompasses all of the above as well as ongoing evaluation, preparation, and improvement to keep the business focused and achieve long-term goals. When a company manages strategically, it deals with short-term problems on an ad hoc basis in a way that does not affect its long-term vision.

Functions of Strategic Financial Management

A company will employ strategic financial management in all organizational operations, which means designing elements that maximize and efficiently use the company’s financial resources. This is where a company needs to be creative as there is no one-size-fits-all approach to strategic management and every company develops elements that reflect its own particular needs and goals. However, some of the more general functions of strategic financial management could include the following.


  • Define goals precisely.
  • Identify and quantify available and potential resources.
  • Write a specific business budget.


  • Help your company be financially efficient and with less waste.
  • Identify the areas where most operating costs are incurred or exceed budgeted costs.
  • Ensure sufficient liquidity to cover operating costs without resorting to external resources.
  • Discover areas where a company can invest its profits to more effectively achieve its goals.

Risk assessment and management

  • Identify, analyze, and mitigate uncertainty in investment decisions.
  • Assessment of the potential for financial commitment; Examine Capital Spending (CapEx) and Workplace Policies.
  • Use risk metrics such as B. Calculations of the degree of operational leverage, standard deviation, and value-at-risk (VaR) strategies.

Establish ongoing proceedings

  • Collect and analyze data.
  • Make consistent financial decisions.
  • Track and analyze variance, the differences between budgeted and actual results.
  • Identify problems and take appropriate corrective action.

Strategic vs tactical financial management

The term “strategic” refers to financial management practices that are geared towards long-term success as opposed to “tactical” management decisions that focus on short-term positioning. When a company is strategic rather than tactical, it makes financial decisions based on what it believes will ultimately produce results, i.e. in the future. To achieve these results, a company sometimes has to tolerate loss in the present.

When strategic management is effective

Part of effective strategic financial management, therefore, may be sacrificing or realigning short-term goals in order to more efficiently achieve the company’s long-term goals. For example, if a company suffered a net loss in the previous year, it may choose to reduce its asset base by closing facilities or downsizing, thereby lowering its operating costs. Such steps can lead to restructuring charges or other one-time items that can have an even greater impact on the company’s finances in the short term, but better position the company for long-term success.

These short-term and long-term tradeoffs often need to be made with multiple stakeholders in mind. For example, shareholders of public companies can discipline management for decisions that have a negative short-term impact on a company’s stock price, even though the same decisions make the company’s long-term health stronger.

Importance of Strategic Financial Management

  • Helps you determine the capital requirements of the business: Financial management helps to estimate the financial resources necessary for the proper functioning and functioning of a business. This is one of the main responsibilities of CFOs. The financial requirements of any business vary based on the size of the business, its profit goal, and various other goals and responsibilities.
  • Helps you decide on the composition of the capital structure: Once the capital requirements of the business are calculated, the next step is for the finance manager to decide what type of capital structure it should have.
  • Helps you choose the right funding source: Since there is another source to raise funds, these are available in the market. This step is simply to choose the most suitable and accurate one.
  • Increased allocation and investment in funds: Once the exact amount of funds has been raised, these funds are invested in various funds that generate income for the business and also meet the goals and objectives of the business.
  • Using the excess amount: It is a decision about the profit made by the company and how it is used.
  • Control of all cash expenses: This simply means managing cash so that none of the expenses are out of budget. It consists of various expenses that require cash payments such as wages and salaries, water and electricity bill expenses, and the amount required to buy raw materials, etc.
  • Control of all finances: It is one of the important functions as it plays a very effective role in achieving the objectives of the company. Ensures that all activities are carried out in accordance with pre-established plans and, if not, the precise control measures are taken.


This is one of the most important techniques required in any business organization because no function in the organization can function properly unless the finances of the business are properly managed. Before using the technique of strategic financial management, it is very important that the objectives of the organization are defined precisely and clearly so that the appropriate financial needs can be calculated and the necessary funds raised in various ways.

The three basic elements of strategic financial management are, first, the formulation of an adequate financial plan. Various controls are then put in place to ensure that all financial activities proceed according to pre-established plans and ultimately decisions related to financial matters are made. From this, it can be concluded that the scope of financial management is very deep in the business and has several important functions.

We also recommend:

Continue Reading

Finance & Accounting

DAYS OF SALES OUTSTANDING- Everything You Need To Know




Many business analysts point out that poor cash management is the leading cause of business bankruptcy. If your company’s cash flow needs some attention, don’t panic! Analyzing a few simple financial metrics can make a big difference. One of the most important is the days of sales outstanding (DSO) ratio. This post will explain what this formula is, how to do a DSO calculation, and how you can improve your DSO. Ready to learn more.

What is Days of Sales Outstanding – DSO?

Days of Sales Outstanding (DSO) is a measure of the average number of days it takes for a business to collect payment after a sale. Often determined monthly, quarterly, or annually, the DSO can be calculated by dividing the number of accounts receivable during a given period by the total value of loan sales in the same period and multiplying the result by the number of days in the period measured.

How to use Days of Sales Outstanding (DSO)

An effective way to use days of sales outstanding measurement is to track a trend line month after month. This shows any change in the company’s ability to charge its customers. If a company is very seasonal, a variation is to compare the measurement with the same metric for the same month of the previous year. This provides a more reasonable basis for comparison.

Regardless of how this measure is used, keep in mind that it is typically made up of a large number of outstanding invoices and therefore does not provide information on the ability to collect a particular invoice. Therefore, it should be supplemented by a continuous review of the outdated claims report and collection letters from the collection staff.

DSO can be a useful measure for an acquirer. You can search for companies with abnormally high DSO numbers to acquire the companies and then improve your loan and collections operations. In this way, they can withdraw part of the working capital of the acquired companies, which reduces the amount of the initial acquisition costs.

Days Sales Outstanding Calculation

Income is created each time you make a sale. However, this often just means that an invoice has been created. It doesn’t count as cash until you see the money in your bank account. This means you have to focus on collecting that cash. Too often, businesses work to increase their sales regardless of their actual cash position, and this can be a disaster for a small business owner.

With that in mind, let’s first look at some key terms:

Cash sale:

A sale that takes place immediately. Payment can be made by card or other forms such as cash, check or electronic check. The defining characteristic is the time of payment, at the time of sale.

Sale of loan:

A sale that will be completed at a later date. Payment can also be made in cash and viewed as a loan sale. The defining characteristic is the timing of payment in the future after the services have been provided.

Accounts receivable (A/R):

The billing term for all outstanding invoices due to your company on a certain date. If you use an accountant for your business, you can provide this information. If not, you can find it yourself by looking at your balance sheet and income statement.

Your days of sales outstanding quota shows the average number of days it will take you to collect the sales on your loan. Using this relationship can streamline the accounts receivable process and increase your profitability by adding predictability to your business. DSOs are often billed monthly, quarterly, or annually.

For your DSO calculation you need:

  • To determine a period
  • Your opening balance
  • Your account balance
  • Total loan sales during this period

The days sales outstanding formula is: 

DSO = (Average Accounts Receivable / Total Credit Sales) x (Number of Days) 

How to calculate days of sales outstanding

To find out the days of sales outstanding, you must obtain information from an old accounts receivable report or a balance sheet. Once this information is collected, you can calculate your DSO.

#1. Determine the period to cover

It is up to you to determine the amount of time you want to cover when calculating the DSO. Smaller businesses may find it more useful to calculate the DSO on a quarterly basis, although businesses that sell on credit frequently must do a DSO calculation on a monthly basis.

#2. Calculate the total amount of initial claims for the period

This information can be found on a balance sheet prepared on the first date of the period you are investigating. For example, if you want to calculate the DSO for the first quarter of 2020, take a balance sheet as of January 1, 2020 to find the beginning balance of your accounts receivable.

#3. Calculate the total amount of accounts receivable at the end of the period

You will receive the ending balance of your accounts receivable in the same way. Just this time, you will prepare a balance report for March 31, 2020.

#4. Determine the average claims for the period.

This is a simple calculation. Just take your beginning balance and your ending balance for the period you selected.

#5. Calculate the total loan turnover for the period.

This calculation can be a bit tricky if you don’t track cash sales separately. If you do this, all you need to do is find out your total sales for the period. Be sure to subtract any returns or adjustments. If you don’t track cash sales automatically, you’ll need to subtract them as well.

#6. Determine the number of days in the specified period

When calculating the DSO for the month, use the number of days in the month. In our example, we calculate the DSO for the quarter. Therefore, we must add the number of days in each month.

  • January: 31 days
  • February: 29 days (leap year)
  • March: 31 days
  • So the total number of days for the first quarter would be 91.

How to Improve DSO

After knowing your DSO, you can determine if you need to improve it. If you have a healthy DSO, congratulations! Monitor regularly to make sure your business remains in good financial shape.

If your DSO needs an upgrade, don’t despair. A few changes to your collection processes can make a big difference. You can improve your DSO by:

  • Advance payment whenever possible – Many of your customers will not resist prepayment. All you have to do is ask!
  • Offer Your Clients Multiple Payment Options – Most clients want to pay you for your services, but you have to make them feel comfortable! Make sure to accept both credit cards and electronic checks.
  • Make Payments As Automated As Possible – If your customers rely on talking to someone in your company to pay a bill, you’re limiting their options and wasting time. Set up recurring online payments so your business can collect invoices automatically.

DSO limitations

As with any metric used to measure the efficiency of a business, there are some limitations todays of sales outstanding that any investor should consider before using it.

When using DSO to compare the cash flows of multiple companies, it is easier to compare companies in the same industry, ideally if they have similar business models and sales figures. As mentioned above, companies of different sizes often have very different capital structures, which can greatly affect DSO calculations, and this often applies to companies in different industries as well.

The DSO is not particularly useful for comparing companies with significant differences in the percentage of credit sales, because determining the DSO of a company with a low percentage of credit sales does not say much about the cash flow of that company. The comparison of these companies with companies with a high percentage of loan sales does not usually suggest much importance either.

Additionally, the DSO is not a perfect indicator of the efficiency of a company’s accounts receivable, as fluctuating sales volumes can affect the DSO, and an increase in sales often lowers the DSO.

However, Delinquent Days Sales Outstanding(DDSO) is a good credit rating alternative that can be used in conjunction with DSO. Like any metric that measures a company’s performance, the DSO should not be viewed alone, but should also be used with other metrics.


By tracking your DSO over time, you can see trends, stay current when DSO increases, and make adjustments to the accounts receivable process.

We also Recommend:

Continue Reading


%d bloggers like this: