Operating Leverage Calculator
Find out how much a change in sales will affect your operating income. The degree of operating leverage (DOL) tells you the multiplier effect -- if DOL is 2.5, a 10% increase in sales produces a 25% increase in EBIT. Higher leverage means bigger profit swings in both directions.
Operating leverage measures how your cost structure amplifies changes in revenue into larger changes in operating income (EBIT). Companies with high fixed costs and low variable costs have high operating leverage.
There are two ways to calculate DOL:
- Percentage change method: DOL = % Change in EBIT / % Change in Sales. If sales rose 10% and EBIT rose 25%, DOL is 2.5.
- Contribution margin method: DOL = Contribution Margin / EBIT. If a company has $600,000 in contribution margin and $250,000 in EBIT, DOL is 2.4.
For example, a software company with $1,000,000 in revenue, $400,000 in variable costs, and $350,000 in fixed costs has a contribution margin of $600,000 and EBIT of $250,000. Its DOL is 2.4, meaning a 10% revenue increase would boost EBIT by 24%.
The Double-Edged Sword
High operating leverage is great when sales are growing -- profits increase faster than revenue. But it is dangerous when sales decline, because profits fall faster too. Airlines, hotels, and manufacturing plants have very high operating leverage because most of their costs (planes, buildings, equipment) are fixed. A 10% drop in revenue can wipe out their entire operating profit.
Service businesses and consulting firms typically have lower operating leverage because their main cost (labor) can be scaled up or down more easily.