A:

The degree of operating leverage measures the percent change of a company's earnings before interest and taxes relative to a percent change in its sales. A high degree of operating leverage indicates that the earnings before interest and taxes experience more fluctuations given a percent change in sales.

The degree of operating leverage is calculated by dividing the percent change in a company's earnings before interest and taxes by its percent change in sales over a specified period. It can also be calculated by subtracting a company's variable costs from its sales and dividing it by the sales less variable and fixed costs.

For example, company ABC has sales of $20 million, fixed costs of $13 million and variable costs of $6 million. Therefore, company ABC's degree of operating leverage is 14 (($20 million - $6 million)/($20 million - $13 million - $6 million)).

Since the degree of operating leverage is high, the company will experience high volatility for a small percentage change in sales. Therefore, a 1% change in sales will cause company ABC's profits to fluctuate by 14%.

On the other hand, company DEF, a competitor of company ABC, has sales of $20 million, fixed costs of $5 million and variable costs of $6 million. Company DEF's degree of operating leverage is 1.56 (($20 million - $6 million)/$20 million - $5 million - $6 million).

The degree of operating leverage for company DEF will experience a lower level of volatility in its profits given a percent change in sales. If there is a 1% increase in sales, company DEF's profit will only increase by 1.56%, whereas company ABC will have a 14% increase in profit.

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. How can I calculate degree of operating leverage on Excel?

    Find out more about the degree of operating leverage, what the ratio measures and how to calculate the degree of operating ... Read Answer >>
  3. 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 >>
  4. 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 >>
  5. How does ratio analysis make it easier to compare different companies?

    Learn what ratio analysis is, how investors can compare companies within the same sector using ratio analysis and how ratios ... Read Answer >>
  6. How can a company raise its asset turnover ratio?

    Find out more about the asset turnover ratio, what it measures, how to calculate the ratio and how a company could increase ... Read Answer >>
Related Articles
  1. Investing

    The Optimal Use Of Financial Leverage In A Corporate Capital Structure

    The amount of debt and equity that makes up a company's capital structure has many risk and return implications.
  2. Personal Finance

    Top 5 Post-Grad Degrees That Lead To High Pay

    These post-grad degrees take a lot of work, but they pay off in the long run.
  3. Personal Finance

    College Degrees of the 1%

    Find out which college majors give you the best odds of joining the wealthiest percentile of Americans.
  4. Investing

    Top Bachelor Degree For A Hedgefund Career

    From economics to statistic analysis, certain bachelor's degrees make graduates more qualified for landing highly sought hedge fund jobs.
  5. Personal Finance

    Work Experience Vs. Education: Which Lands You The Best Job?

    It's a long running argument, and we look at all the angles to help you determine what's right for you.
  6. Managing Wealth

    Post-Grad Degrees That Pay The Highest

    A post-graduate degree could be well worth the extra time and expense.
  7. Investing

    Leverage: Increasing your real estate net worth

    Using leverage in housing purchase can significantly increase your real estate net worth if you use it carefully. Learn more on how increasing leverage can benefit your net worth.
  8. Personal Finance

    Masters Degree Vs. Work Experience: Which One Is More Valuable?

    Some argue that a master's degree only worsens student's financial situations, but future earnings data shows there can be a real financial benefit.
  9. Personal Finance

    When Is College The Wrong Investment?

    Attending a very expensive college with the wrong degree could turn into a bad investment due to low salaries and high debt.
  10. Investing

    Dissecting Leveraged ETF Returns

    These funds are a relatively new product to most investors, but they could be what you need for increased returns.
RELATED TERMS
  1. Operating Leverage

    Operating leverage is a measurement of the degree to which a ...
  2. Degree Of Combined Leverage - DCL

    A leverage ratio that summarizes the combined effect the degree ...
  3. Degree Of Operating Leverage - DOL

    A type of leverage ratio summarizing the effect a particular ...
  4. Leverage

    The use of various financial instruments or borrowed capital, ...
  5. Homemade Leverage

    Homemade leverage is when a person invests in a company with ...
  6. Maximum Leverage

    The maximum size of a trading position permitted through a leveraged ...
Hot Definitions
  1. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  2. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
  3. Cost of Goods Sold - COGS

    Cost of goods sold (COGS) is the direct costs attributable to the production of the goods sold in a company.
  4. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and expenses incurred during a specified period of time, usually ...
  5. Monte Carlo Simulation

    Monte Carlo simulations are used to model the probability of different outcomes in a process that cannot easily be predicted ...
  6. Price Elasticity of Demand

    Price elasticity of demand is a measure of the change in the quantity demanded or purchased of a product in relation to its ...
Trading Center