Alternative Definition of Operating Leverage

Operating leverage can also be defined and illustrated in another way. This is a more precise measurement in terms of degree of operating leverage (DOL). The DOL measures in quantitative terms the extent or degree of operating leverage.

When proportionate change in EBIT as a result of a given change in sales is more than the proportionate change in sales, operating leverage exists. The greater the DOL the higher is the operating leverage. Symbolically,

1

Since the DOL exceeds 1 in both the illustrations, operating leverage exists. However, the degree of operating leverage is higher (3 times) in the case of the firm in compared to the firm in the respective quotients being 6 and 2. The quotients mean that for every 1 per cent change in sales, there will he 6 per cent and 2 per cent change in EBIT in the direction the sales change.

However, operating leverage exists only when there are fixed operating costs. If there are no fixed operating costs, there will he no operating leverage.

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