Question

What is operating leverage and how is Return on Equity impacted?

Answer 1

Operating Leverage is a measure that tells us the effect of change in Operating Profit due to change in Sales of the company. Operating leverage can be increased by increasing fixed costs.

EFFECT OF OPERATING LEVERAGE ON ROE
With High Operating Leverage, a small change in sales will lead to higher changes in the Net income, which will further lead to changes in the Return on Equity

High Operating leverage increases Return on Equity at a greater rate when sales of the company increase. On the contrary, ROE decreases at an accelerated rate when sales of the company decrease.