What this calculator does
Operating leverage measures how much a company's profit amplifies changes in sales. A business with high fixed costs has high leverage: sales above breakeven drop almost entirely into profit, and sales below it fall away just as fast.
The effect near breakeven is dramatic. With $250,000 of fixed costs the leverage is 2.67 times, so a 10 per cent rise in sales lifts operating profit 26.7 per cent. Raise the fixed costs to $350,000 and leverage jumps to 8.00 times, turning the same 10 per cent sales rise into an 80.0 per cent profit rise, and a 10 per cent fall into an equally severe collapse.
The formula
Contribution margin is sales less variable costs, and operating profit is that margin less fixed costs. Dividing the contribution margin by operating profit gives the leverage factor.
| Term | Meaning |
|---|---|
| Contribution margin | Sales less variable costs, the amount available to cover fixed costs. |
| Operating leverage | The multiple by which a percentage change in sales moves operating profit. |
| Fixed costs | Costs that do not vary with volume, which are what create leverage. |
The inputs explained
| Field | What to enter |
|---|---|
| Sales revenue ($) | Total sales revenue for the period. |
| Variable costs ($) | Variable costs, which move in proportion to sales. |
| Fixed costs ($) | Fixed costs, which do not change with volume. |
When to use it
Understanding earnings volatility
A highly leveraged business will show far more profit variation than its sales variation suggests.
Assessing a cost structure decision
Replacing variable costs with fixed ones, such as buying equipment rather than outsourcing, raises leverage.
Stress-testing a downturn
Leverage works in both directions, and the downside is where it matters most.
Worked examples
Every figure in the tables below is produced by this page’s own calculator at build time, so the numbers and the tool always agree. Select any row to load that scenario.
How do fixed costs drive operating leverage?
The same sales and margin with three fixed cost bases.
| Fixed costs | Degree of operating leverage | If sales rise 10%, EBIT is expected to rise about |
|---|---|---|
| $150k | 1.60× | 16.0% |
| $250k | 2.67× | 26.7% |
| $350k | 8.00× | 80.0% |
Questions
Is high operating leverage good or bad?
Both, depending on direction. It magnifies profit when sales grow and magnifies losses when they fall. It suits businesses with stable, predictable demand and is dangerous for cyclical ones.
Why does leverage rise near breakeven?
Because the denominator, operating profit, approaches zero while the contribution margin does not. Any percentage change measured against a tiny base is enormous, which is exactly what makes operating near breakeven so precarious.
How does this differ from financial leverage?
Operating leverage comes from the fixed costs in the business itself; financial leverage comes from fixed interest payments on debt. Both amplify swings, and a company with a lot of each is doubly exposed.
Which industries have high operating leverage?
Airlines, hotels, software and manufacturing, where most costs are incurred regardless of volume. Retail and distribution, where cost of goods dominates, tend to have much lower leverage.
For the sales level where profit turns positive, see the break-even calculator. For the contribution margin on its own, see the contribution margin calculator.