In this tutorial, we’ll go over the finer details of Operating Leverage, including its meaning, formula and step-by-step calculations. After that, we will use the Colgate Case Study to compute Operating Leverage and interpret the results. You can download the Colgate Operating Leverage template from this link – https://www.wallstreetmojo.com/ratio-analysis-template/
What is Operating Leverage?
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Operating leverage is an accounting metric that assists analysts in analyzing how a company's operations are related to its revenues. Moreover, the ratio details how much of an increase in operating profit the company will have with a specific percentage increase in sales – emphasizing the predictability of sales.
Formula
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Degree of Operating Leverage Formula = % change in EBIT / % change in Sales.
Interpretation
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– Lower Operating Leverage means higher variable costs and lower fixed costs. In this situation, a
business must generate a minimum level of sales to pay its fixed costs. It can earn additional profit in terms of Selling Price minus Variable Cost until it achieves the break-even point, where all of its fixed costs are covered.
– Lower variable expenses and higher fixed costs are associated with higher operating leverage. The
break-even point will be higher in this case since the fixed costs are higher. The benefit is that once the break-even point is reached, the company will be able to earn a greater profit on each product because the variable cost is low.
For more details, you can refer to our article – https://www.wallstreetmojo.com/operating-leverage/
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