Degree of Operating Leverage

Degree of operating leverage is the multiple by which

operating income of a business changes in response
to a given percentage change in sales.
Degree of operating leverage is a measure of the
extent of operating leverage i.e. the relationship
between operating income and sales of a business. If
operating income is more sensitive to changes in
sales, the business is said to have high operating
leverage and vice versa. Similarly, if operating profit
margin is higher, the business is said to have high
operating leverage and vice versa.
Formulas
Degree of operating leverage can be calculated using
any of the following formulas:
change in operating
income
changes in sales
contribution margin
Degree of operating leverage =
operating income
sales variable costs
Degree of operating
sales variable costs
leverage =
fixed costs
contribution margin
Degree of operating
percentage
leverage =
operating margin
Degree of operating
leverage =

Example
Calculate degree of operating leverage in the
following cases and predict the increase in operating
income subject to 15% increase in sales.
Company A: operating income increases by 15% if
sales increase by 10%.
Company B: sales are $2,000,000, contribution
margin ratio is 40% and fixed costs are $400,000
Solution
Company A:
Degree of operating leverage = % change in
operating income/% change in sales = 15%/10% =
1.5
In response to a 15% increase sales, operating
income will increase by 22.5% [=1.5 15%]
Company B:
Operating margin = ($2,000,000 0.4 $400,000)
$2,000,000 = 20%
Degree of operating leverage = contribution margin
percentage/operating margin = $40% 20% = 2%
Increase in operating income in response to 15%
increase in sales = 2 15% = 30%