Question

What is operating leverage?

		A measure of how much a debt a firm uses to finance investments.
		A measure of the breakeven point for a company.
		A measure of how sensitive a company's profits are to changes in demand.
		The production environment in a company.

Answer 1

Answer.

Correct answer is:

A measure of how sensitive a company's profits are to changes in demand.

Operating Leverage:

Operating leverage is a cost-accounting formula that measures the degree to which a firm or project can increase operating income by increasing revenue. A business that generates sales with a high gross margin and low variable costs has high operating leverage.

The Formula for Operating Leverage Is

Degree of operating leverage=Contribution margin/EBIT

The higher the degree of operating leverage, the greater the potential danger from forecasting risk, in which a relatively small error in forecasting sales can be magnified into large errors in cash flow projections.

The degree of operating leverage (DOL) is a multiple that measures how much the operating income of a company will change in response to a change in sales. Companies with a large proportion of fixed costs to variable costs have higher levels of operating leverage.

The DOL ratio assists analysts in determining the impact of any change in sales on company earnings.