Degree of Operating Leverage = % Change in EBIT ÷ % Change in Revenue
High operating leverage means small revenue changes swing profit hard.
What it is
Operating leverage measures how sensitive a company's operating profit is to changes in revenue. A business with high fixed costs and low variable costs has high operating leverage: once it covers its fixed costs, additional sales drop heavily to the bottom line. A business with mostly variable costs has low operating leverage, with profit moving more gently in line with sales.
Why it matters
High operating leverage magnifies the upside in good times but also magnifies losses when sales fall, making earnings more volatile and more exposed to a downturn. Understanding it helps you anticipate how a company's margins might swing as revenue rises or contracts.
How it's calculated
The degree of operating leverage compares the percentage change in operating income (EBIT) to the percentage change in revenue; a reading of 2 means operating profit moves roughly twice as fast as sales.
How Quintarthai uses it
You can gauge operating leverage by watching how operating margin expands or contracts versus revenue on the Financials 10-yr and Ratios tabs of a company's deep-analysis page — open a company page.
Cross-border note. Operating leverage is a cost-structure concept and works identically for Canadian and US companies; just ensure revenue and EBIT are measured in the same currency and over the same fiscal periods when you compute the percentage changes.
FAQ
Is high operating leverage good or bad?
It is a double-edged sword. When revenue is rising it boosts profit growth far above sales growth, but when revenue falls it accelerates the drop in profit. Whether it is desirable depends on how stable and predictable the company's sales are.
How is operating leverage different from financial leverage?
Operating leverage comes from the mix of fixed versus variable operating costs and affects how EBIT responds to sales. Financial leverage comes from debt and affects how net income responds to EBIT. A company can have a lot of one and little of the other.
Check your understanding
A company with high fixed costs and low variable costs is said to have high operating leverage. What does this imply about its profits?
With fixed costs already covered, extra sales drop heavily to profit, but when sales fall the same fixed costs magnify the decline, making earnings more volatile.