Question

The degree of operating leverage of company A is higher than company B. If sales decrease by 10% for each company, then which company would have higher net operating income and why?

Answer 1

Operating Leverage is a measure of how sensitive is the net operating income to the chnge in sales. The higher the operating leverage, higher will be the change in operating income.

In the case given above, if A is having higher operating leverage, then a decrease in sales by 10% will decrease the operating income of A, which means Company B will have higher net operating income.

Operating leverage is measured by dividing contribution margin by Net operating Income.