Operating Leverage

Business Finance

Operating leverage measures how sensitive operating income is to changes in revenue, based on the mix of fixed and variable costs. High operating leverage = small revenue changes cause large operating income changes. Software businesses have high operating leverage (mostly fixed costs); consultancies have low operating leverage (mostly variable labor costs). Calculate as Contribution Margin / Operating Income. A company with 5× operating leverage sees 50% operating income decline from a 10% revenue decline. High operating leverage amplifies both growth and decline — desirable in growth markets, dangerous in cyclical or declining markets. Capital structure choices (debt = financial leverage) compound operating leverage effects.