Degree of Operating Leverage

A type of leverage ratio summarizing the effect a particular amount of operating leverage has on a company's earnings before interest and taxes (EBIT). Operating leverage involves using a large proportion of fixed costs to variable costs in the operations of the firm. The higher the degree of operating leverage, the more volatile the EBIT figure will be relative to a given change in sales, all other things remaining the same.

This ratio is useful as it helps the user in determining the effects that a given level of operating leverage has on the earnings potential of the firm. This ratio can also be used to help the firm determine the most appropriate level of operating leverage in order to maximize the company's EBIT.

Definition and Explanation of Operating Leverage:

A lever is a tool for multiplying force. Using a lever, a massive object can be moved with only a modest amount of force.

In Business, operating leverage serves a similar purpose. Operating leverage is a measure of how sensitive net operating income is to percentage changes in sales. Operating leverage acts as a multiplier. If operating leverage is high, a small percentage increase in sales can produce a much larger percentage increase in net operating income. It is high near the break even point and decreases as the sales and profit increase.

Definition of Degree of Operating Leverage (DOL):

The degree of operating leverage (DOL) is a measure, at a given level of sales of how a percentage change in sales volume will effect profits.

The percentage of fixed costs in a company's cost structure. Generally, the higher the operatingleverage, the more a company's income is affected by fluctuation in sales volume. The higher income vs. sales ratioresults from a smaller portion of variable costs, which means the company does not have to pay as much additionalmoney for each unit produced or sold. The more significant the volume of sales, the more beneficial the investment in fixed costs becomes....