Quick Finance Tip – Operating Leverage and Degree of Operating Leverage

Degree of Operating Leverage (DOL) and in a broader sense Operating Leverage, shows the impact on income from changes in sales.

• Formula: DOL = (Q(P-V)) / (Q(P-V)-F); Q = number of units, V = variable operating cost per unit, F = fixed operating costs, and P = Price.
• Formula: Change in Income / Change in Sales

 
Note that P-V is the per unit contribution margin and Q(P-V) is the contribution margin.
 
Degree of Operating Leverage calculates the operating income elasticity which is a measure of the sensitivity (or changes) in one item to another. Industries that tend to have high operating leverages are those that invest up front to produce a product but little on making or distributing it (i.e. software, pharmaceuticals). Retailers typically have lower operating leverage because COGS is variable.