Question

What is meant by the statement, my company has good operating leverage? How does good operating leverage magnify earnings results with modest revenue increase?

  

Answer 1

Solution:

Operating leverage is ratio contribution and Operating income. Good operating leverage implies that company is having high amount variable cost and lower amount of fixed costs. If operating leverage is high, it means company is having high fixed cost and high breakeven point. A small change in revenue would have high impact on earnings if operating leverage of company is high and vice versa.

The relation of earnings and revenue with operating leverage is:

% increase in earnings = % increase in sales * Operating leverage

Business with high operating leverage are very responsive to variations in sales.