Definition
Operating leverage measures how sensitive operating income is to revenue changes. Companies with high fixed costs and low variable costs have high operating leverage—small revenue increases produce outsized profit gains, but revenue declines cause disproportionate profit drops. This is why airlines and hotels are more volatile than consulting firms.
functions Formula
DOL = % Change in Operating Income / % Change in Revenue
lightbulb Example
Revenue increases 10% and operating income increases 30%. DOL = 30%/10% = 3.0x. For every 1% revenue change, operating income changes 3%—magnifying both gains and losses.
verified_user Key Points
- High fixed costs create high operating leverage
- Amplifies both profits in upturns and losses in downturns
- Software companies have very high operating leverage
- Understanding DOL is essential for earnings sensitivity analysis