Published On:Sunday 27 November 2011
Posted by Muhammad Atif Saeed
Operating leverage
Operating leverage
Operating leverage is a measure of how sensitive net operating income is to percentage changes in sale. Operating leverage acts as a multiplier. If operating leverage is high a small percentage increase in sale can produce a much larger percentage increase in net operating income. A manager can use the degree of operating leverage to quickly estimate what impact various percentage changes in sales will have on profits, without the necessity of preparing detailed income statements. If a company is near its break even point, then even small percentage increases in sales can yield large percentage increases in profits. This explains why management will often work very hard for only a small increase in small volume. If degree of operating leverage is 5 , then a 6% increase in sales would translate into 30% increase in profit.
Degree of operating leverage= Contribution Margin/ Net operating income
• The degree of operating leverage is a measure at a given level of sale, of how a percentage change in sale volume will effect profit.
Sale Rs. 100,000
Variable cost Rs. 40,000
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Contribution Rs. 60,000
Fixed cost Rs. 50,000
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Profit Rs. 10,000
Degree of operating leverage is 6
