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In Class, we have discussed more costing topics, such as weighted contribution margin and Operating Leverage....

In Class, we have discussed more costing topics, such as weighted contribution margin and Operating Leverage. Operating Leverage is frequently measured in business by companies and their creditors. Tell us what you know about this important financial topic. Why do you think it is so important not only to companies measuring their profitability, but also of great concern to their creditors.

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Answer #1

UNDERSTANDING OPERATING LEVERAGE

Operating Leverage simply implies Higher Operating Income due to Higher Revenue. Operating leverage is the degree to which a firm or project can increase operating income by increasing revenue. A business that generates sales with a high gross margin and low variable costs has high operating leverage.

Degree Of Operating Leverage = Contribution Margin/ Net Operating Income.

Hence this concept is impotant for both Companies and their Creditors as it will prove the Company's ability to payback the credit on time and have better Interest Coverage Ratios. The higher the contribution margin, the higher is the Interest Coverage ratio which will benefit the Creditors.

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