Operating Leverage

Key Highlights

• Operating leverage shows how much a company’s profits can swing based on changes in its sales.

• It depends on how much of the company’s costs are fixed (like rent or salaries) versus variable.

What is Operating Leverage?

Operating leverage shows how much a company’s profits can swing based on changes in its sales. It depends on how much of the company’s costs are fixed (like rent or salaries) versus variable (like materials).

Why it Matters?

• High operating leverage: A company with lots of fixed costs sees big profit jumps when sales rise, but big losses if sales drop. Think factories or tech firms with heavy upfront costs.

• Low operating leverage: A company with more variable costs has steadier profits, even if sales change. Think retail with costs tied to inventory.

Operating Leverage Formula

Where:

Q: Quantity sold
P: Price per unit
V: Variable cost per unit
F: Fixed operating costs

How it’s Measured?

The Degree of Operating Leverage (DOL) tells you how sensitive profits are to sales changes.

For example, if a 10% sales increase boosts profits by 20%, the DOL is 2.