Degree of Operating Leverage

The degree of operating leverage (DOL) is a measure of how a company's operating income changes in response to a change in sales. It is calculated by dividing the company's contribution margin by its operating income.

The contribution margin is the amount of revenue remaining after deducting variable costs. The operating income is the amount of income remaining after deducting all operating expenses, including variable and fixed costs.

A high degree of operating leverage means that a small change in sales will result in a large change in operating income. This is because a company with a high degree of operating leverage has a large proportion of fixed costs. As a result, when sales increase, the company's operating income increases by a greater percentage than the increase in sales. Conversely, when sales decrease, the company's operating income decreases by a greater percentage than the decrease in sales.

A low degree of operating leverage means that a large change in sales will result in a small change in operating income. This is because a company with a low degree of operating leverage has a small proportion of fixed costs. As a result, when sales increase, the company's operating income increases by a smaller percentage than the increase in sales. Conversely, when sales decrease, the company's operating income decreases by a smaller percentage than the decrease in sales.

The degree of operating leverage can be used to assess a company's financial risk. A company with a high degree of operating leverage is more vulnerable to changes in sales than a company with a low degree of operating leverage. This is because a company with a high degree of operating leverage has a greater proportion of fixed costs that must be paid regardless of the level of sales. As a result, if sales decrease, the company's operating income will decrease by a greater percentage than the decrease in sales. This can make it difficult for the company to meet its financial obligations.

The degree of operating leverage can also be used to assess a company's profitability. A company with a high degree of operating leverage is more profitable than a company with a low degree of operating leverage. This is because a company with a high degree of operating leverage has a greater proportion of fixed costs that are deducted from its revenue. As a result, the company's operating income is higher than the operating income of a company with a low degree of operating leverage.