What is Degree of operating leverage?
In short
The degree of operating leverage measures how sensitive operating income is to changes in sales: the percentage change in operating income divided by the percentage change in sales, or contribution margin divided by operating income.
Key takeaways
- Companies with high fixed costs have high operating leverage.
- High leverage magnifies profits when sales rise and losses when they fall.
- It is highest just above the break-even point.
Example
Contribution margin of $400,000 and operating income of $100,000: the degree is 4, so a 10% rise in sales lifts operating income 40%.
Where it's tested
BAR: Financial Statement Analysis — study notes, a five-minute revision sheet and practice questions.
Practise: 3 questions
Question 1 of 3 · 0 answered
A company with a current ratio of 0.8 uses cash to pay off an accounts payable balance. What is the effect on the current ratio?