finance
Operating Leverage
How much profit grows when revenue grows - driven by the ratio of fixed to variable costs.
Definition
Operating leverage measures how much profit changes with a change in revenue. High operating leverage (mostly fixed costs): a 10% increase in revenue produces a much bigger % increase in profit, because fixed costs don't rise. Low operating leverage (mostly variable costs): a 10% increase in revenue produces a smaller increase in profit because variable costs rise too. Software businesses have very high operating leverage; service businesses have moderate; manufacturing varies. High operating leverage amplifies both gains and losses - great in growth, dangerous in downturn.
In your business
- →Calculate operating leverage (% change in operating profit / % change in revenue) annually
- →High operating leverage is great when growing - amplifies the upside
- →High operating leverage is dangerous in downturns - revenue dips become outsized profit dips