what the degree of operating leverage can tell you
the higher the degree of operating leverage dol the more sensitive a company s earnings before interest and taxes ebit are to changes in sales assuming all other variables remain constant the dol ratio helps analysts determine what the impact of any change in sales will be on the company s earnings operating leverage measures a company s fixed costs as a percentage of its total costs it is used to evaluate a business breakeven point which is where sales are high enough to pay for all costs and the profit is zero 2 a company with high operating leverage has a large proportion of fixed costs which means that a big increase in sales can lead to outsized changes in profits a company with low operating leverage has a large proportion of variable costs which means that it earns a smaller profit on each sale but does not have to increase sales as much to cover its lower fixed costs example of how to use degree of operating leverageas a hypothetical example say company x has 500 000 in sales in year one and 600 000 in sales in year two in year one the company s operating expenses were 150 000 while in year two the operating expenses were 175 000 year one e b i t 5 0 0 0 0 0 1 5 0 0 0 0 3 5 0 0 0 0 year two e b i t 6 0 0 0 0 0 1 7 5 0 0 0 4 2 5 0 0 0 begin aligned text year one ebit 500 000 150 000 350 000 text year two ebit 600 000 175 000 425 000 end aligned year one ebit 500 000 150 000 350 000year two ebit 600 000 175 000 425 000 next the percentage change in the ebit values and the percentage change in the sales figures are calculated as change in e b i t 4 2 5 0 0 0 3 5 0 0 0 0 1 2 1 4 3 change in sales 6 0 0 0 0 0 5 0 0 0 0 0 1 2 0 begin aligned text change in ebit 425 000 div 350 000 1 21 43 text change in sales 600 000 div 500 000 1 20 end aligned change in ebit change in sales 425 000 350 000 1 21 43 600 000 500 000 1 20 lastly the dol ratio is calculated as d o l change in operating income change in sales 2 1 4 3 2 0 1 0 7 1 4 begin aligned dol frac text change in operating income text change in sales frac 21 43 20 1 0714 end aligned dol change in sales change in operating income 20 21 43 1 0714 the difference between degree of operating leverage and degree of combined leveragethe degree of combined leverage dcl extends the degree of operating leverage to get a fuller picture of a company s ability to generate profits from sales it multiplies dol by degrees of financial leverage dfl weighted by the ratio of change in earnings per share eps over change in sales 3this ratio summarizes the effects of combining financial and operating leverage and what effect this combination or variations of this combination has on the corporation s earnings not all corporations use both operating and financial leverage but this formula can be used if they do a firm with a relatively high level of combined leverage is seen as riskier than a firm with less combined leverage because high leverage means more fixed costs to the firm 