Operating Leverage
Operating leverage is a measure of how much a company’s profits are affected by changes in its operating costs. It is calculated by dividing a company’s fixed costs by its total operating costs. The higher the operating leverage, the more sensitive a company’s profits are to changes in its operating costs. For example, if a company has a high operating leverage, a small increase in its operating costs can lead to a large decrease in its profits.
History of Operating Leverage
The concept of operating leverage was first introduced by economist John Maynard Keynes in his 1936 book, The General Theory of Employment, Interest, and Money. Keynes argued that businesses with high operating leverage were more vulnerable to changes in the economy, as their profits were more sensitive to changes in their operating costs. Since then, operating leverage has become an important tool for analyzing a company’s financial performance.
Comparison of Operating Leverage
| Company | Fixed Costs | Total Operating Costs | Operating Leverage |
|---|---|---|---|
| Company A | $100,000 | $500,000 | 2.0 |
| Company B | $200,000 | $1,000,000 | 2.0 |
| Company C | $500,000 | $2,000,000 | 4.0 |
Summary
Operating leverage is a measure of how much a company’s profits are affected by changes in its operating costs. It is calculated by dividing a company’s fixed costs by its total operating costs. Companies with higher operating leverage are more sensitive to changes in their operating costs, and thus more vulnerable to changes in the economy. For more information on operating leverage, visit websites such as Investopedia, The Balance, and Investing Answers.
See Also
- Financial Leverage
- Debt Leverage
- Equity Leverage
- Leverage Ratio
- Fixed Costs
- Variable Costs
- Cost of Capital
- Return on Investment
- Break-Even Point
- Margin of Safety
