Operating Leverage
The degree to which a company uses fixed costs in operations, determining how changes in sales volume affect operating profit with significant risk implications.
Operating Leverage
The degree to which a company uses fixed costs in its operations, determining how changes in sales volume affect operating profit and measuring a business’s sensitivity to sales fluctuations.
For example, a software company with $10 million in fixed costs (development, salaries, infrastructure) and only $1 million in variable costs has high operating leverage, where a 10% increase in sales might drive a 30% increase in operating profit due to the significant fixed cost base.
High operating leverage acts as a double-edged sword: it magnifies profits when sales increase but also amplifies losses when sales decline. Companies with substantial investments in technology, equipment, or facilities typically have higher operating leverage than those with predominantly variable cost structures. Understanding operating leverage helps management assess business risk, plan for volume fluctuations, and make strategic decisions about cost structure and pricing.