Question

4. Define operating leverage, discuss the appropriate level of operating leverage for a start-up company, a company in a growing market, and a company with a product in a mature market.

Answer 1

Define operating leverage

Operating leverage is the ratio of a company's fixed costs to its variable costs. In a sense, operating leverage is a means to calculating a company's breakeven point. However, it's also clear from the formula that companies with high operating leverage ratios can essentially make more money from incremental revenues than other companies, because they don't have to increase costs proportionately to make those sales. Accordingly, companies with high operating leverage ratios are poised to reap more benefits from good marketing, economic pickups, or other conditions that tend to boost sales.

A firm that makes sales providing a very high gross margin and fewer fixed and variable cost has much leverage.

A Company with high fixed cost and low variiable cost has high operating leverage.

Where as a company with low fixed cost and high variable cost has low operating leverage.

High Leverage More Dependent on sales for profitability.

Start Up:Will be having higher operating leverage.

Mature Market :Will be having low operating leverage.

Growing Market :Will be having higher operating leverage.