Operating leverage

Operating leverage is a measure of how revenue growth translates into growth in operating income. It is a measure of leverage, and of how risky, or volatile, a company's operating income is.

There are various measures of operating leverage, which can be interpreted analogously to financial leverage.

One analogy is "fixed costs + variable costs = total costs ..similar to.. debt + equity = assets". This analogy is partly motivated because (for a given amount of debt) debt servicing is a fixed cost. This leads to two measures of operating leverage:

One measure is fixed costs to total costs:

Compare to debt to value, which is

Another measure is fixed costs to variable costs:

Compare to debt to equity ratio:

Both of these measures depend on sales: if the unit variable cost is constant, then as sales increase, operating leverage (as measured by fixed costs to total costs or variable costs) decreases.

Contribution margin is a measure of operating leverage: the higher the contribution margin is (the lower variable costs are as a percentage of total costs), the faster the profits increase with sales. Note that unlike other measures of operating leverage, in the linear Cost-Volume-Profit Analysis Model, contribution margin is a fixed quantity, and does not change with Sales. Contribution = Sales - Variable Cost

Operating leverage can also be measured in terms of change in operating income for a given change in sales (revenue).

The Degree of Operating Leverage (DOL) can be computed in a number of equivalent ways; one way it is defined as the ratio of the percentage change in Operating Income for a given percentage change in Sales (Brigham 1995, p. 426):

This can also be computed as Total Contribution Margin over Operating Income:

...
Wikipedia