Question

minimum of 300 words

Explain what operating leverage

is and how it affects a hospitality

operation’s profits and exposure to

risk.

Answer 1

Operating leverage may be defined as the firm’s ability to use fixed operating costs to magnify the effects of changes in sales on its earning before interest and taxes.It is determined by the relationship between the firm’s sales revenues and its earning before interest and taxes.

Operating leverage is highest in companies that have a high proportion of fixed operating costs in relation to variable operating costs. This kind of company uses more fixed assets in its operations. Conversely, operating leverage is lowest in companies that have a low proportion of fixed operating costs in relation to variable operating costs.

Operating leverage, essentially, measures the proportion of fixed costs to your overall costs. Higher Operating Leverage means that you have more fixed costs in your cost structure. Lower operating leverage means that you have less fixed costs in your cost structure.

Effects of Operating leverage in hospitality operation's profits:

1. Higher operting leverage will survive the hospitality sector from periods of lower revenue in a weak company.
2. company with high fixed costs benefits from high operating leverage. If sales accelerate, its fixed costs weigh less on its operating margin which should rise more than for a company with variable costs. On the other hand, when sales shrink, a high operating leverage may drag on a company's profits.

Exposure to Risk

companies assess their business risk by capturing a variety of factors that may result in lower-than-anticipated profits or losses.

1. One of the most important factors that affect a company's business risk is operating leverage; it occurs when a company must incur fixed costs during the production of its goods and services. A higher proportion of fixed costs in the production process means that the operating leverage is higher and the company has more business risk.
2. When a firm incurs fixed costs in the production process, the percentage change in profits when sales volume grows is larger than the percentage change in sales. When the sales volume declines, the negative percentage change in profits is larger than the decline in sales. Operating leverage reaps large benefits in good times when sales grow, but it significantly amplifies losses in bad times, resulting in a large business risk for a company.