Operating Leverage

Loading the player...

What is 'Operating Leverage'

Operating leverage is a measurement of the degree to which a firm or project incurs a combination of fixed and variable costs.

1. A business that makes few sales, with each sale providing a very high gross margin, is said to be highly leveraged. A business that makes many sales, with each sale contributing a very slight margin, is said to be less leveraged. As the volume of sales in a business increases, each new sale contributes less to fixed costs and more to profitability.

2. A business that has a higher proportion of fixed costs and a lower proportion of variable costs is said to have used more operating leverage. Those businesses with lower fixed costs and higher variable costs are said to employ less operating leverage.

BREAKING DOWN 'Operating Leverage'

The higher the degree of operating leverage, the greater the potential danger from forecasting risk. That is, if a relatively small error is made in forecasting sales, it can be magnified into large errors in cash flow projections. The opposite is true for businesses that are less leveraged. A business that sells millions of products a year, with each contributing slightly to paying for fixed costs, is not as dependent on each individual sale.

For example, convenience stores are significantly less leveraged than high-end car dealerships.

RELATED TERMS
  1. Degree Of Operating Leverage - ...

    A type of leverage ratio summarizing the effect a particular ...
  2. Degree Of Combined Leverage - DCL

    A leverage ratio that summarizes the combined effect the degree ...
  3. Leverage

    1. The use of various financial instruments or borrowed capital, ...
  4. Operating Cost

    Expenses associated with the maintenance and administration of ...
  5. Leverage Build Up

    The accumulation of additional debt to enter a position that ...
  6. Maximum Leverage

    The maximum size of a trading position permitted through a leveraged ...
Related Articles
  1. Investing

    The Operating Leverage And DOL

    Operating leverage tells investors about the relationship between a company's fixed and variable costs. The higher a company's fixed costs in relation to its variable costs, the greater its operating ...
  2. Investing

    Operating Leverage Captures Relationships

    Find out how fixed and variable costs interact to shed new light on old companies.
  3. Investing

    Leverage: Is It Good for Your Portfolio?

    Discover the concept of financial leverage. Learn multiple ways to get leverage in your portfolio, and decide if leverage is a good idea for you.
  4. Trading

    Borrowing Smart In A Debt-Filled World

    Leveraging your money can have many perks, but it's not always the smartest financial plan.
  5. Managing Wealth

    Introduction To Hedge Funds

    Find out how these highly leveraged funds operate.
  6. Investing

    Explaining Leveraged Loans

    Leveraged loans are loans extended to companies or people who already have large amounts of debt.
  7. Investing

    Leverage: What It Is And How It Works

    Leverage is an investment strategy of using borrowed money to generate outsized investment returns. Before getting into greater detail on how leverage works in an investment context, it is useful ...
  8. Investing

    Leverage

    Learn more on how leveraged investing can help you with higher investment profits through the use of borrowed money.
  9. Trading

    Adding Leverage To Your Forex Trading

    The use of margin to trade in the foreign exchange market can magnify profit opportunities.
  10. Trading

    Forex Leverage: A Double-Edged Sword

    Find out how this flexible and customizable tool magnifies both gains and losses.
RELATED FAQS
  1. What is the difference between operating leverage and financial leverage?

    Discover the two equity valuation metrics, operating leverage and financial leverage, how they are similar and what differentiates ... Read Answer >>
  2. What are the risks of having both high operating leverage and high financial leverage?

    In finance, the term leverage arises often. Both investors and companies employ leverage to generate greater returns on their ... Read Answer >>
  3. How can a firm bring down its operating leverage?

    Discover how to determine a company's operating leverage and how this metric can be helpful to analysts and investors when ... Read Answer >>
  4. What is the relationship between degree of operating leverage and profits?

    Find out why a company's degree of operating leverage is an important consideration when predicting future operating income ... Read Answer >>
  5. How does operating leverage affect business risk?

    Learn how operating leverage affects business risk and how companies measure it. Review a relevant example of operating leverage ... Read Answer >>
  6. How do I calculate the degree of operating leverage?

    Learn about the degree of operating leverage, what it measures and how to calculate a company's degree of operating leverage ... Read Answer >>
Hot Definitions
  1. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  2. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  3. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  4. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  5. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  6. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
Trading Center