Operating leverage is the relationship between a company’s fixed and variable costs. Fixed costs for a company are the costs that do not change with an increase or decrease in the amount of goods or services produced. Variable costs are the costs that vary depending on a company’s production volume. They rise as production increases and fall as production decreases.
If a company’s fixed costs are higher than its variable costs, than their operating leverage is high. With a high operating leverage, a company will see its profits go up when its production increases. This is because fixed costs stay the same.
The measure of how well a company generates profit using its fixed costs is the degree of operating leverage. This is calculated by subtracting variable costs from sales, and then dividing by profit.
– Information compiled by Anthony Ahlegian