Operating leverage measures how sharply profits respond to a change in sales. Combine it with financial leverage to see how a sales swing flows through to operating income and pre-tax earnings.
How it works
Measure how strongly operating income and pre-tax earnings respond to a change in sales, combining operating leverage from fixed costs with financial leverage from interest.
DOL = Contribution margin ÷ EBIT
DFL = EBIT ÷ (EBIT − Interest)
DTL = DOL × DFL = Contribution margin ÷ Pre-tax income
% change in EBIT ≈ DOL × % change in salesCommon uses
- Assessing earnings risk from a high fixed-cost structure
- Capital-structure and financing decisions
- Explaining profit volatility to investors and lenders
Worked example
The calculator above opens with this example. Change any input to see the results update instantly, or select Reset to return to these figures.
| Sales | $5,000,000 |
| Variable costs | $2,900,000 |
| Fixed operating costs | $1,350,000 |
| Interest expense | $180,000 |
| Sales change to test | 10% |
| Degree of operating leverage | 2.80× |
| Degree of financial leverage | 1.32× |
| Degree of total leverage | 3.68× |
| EBIT | $750,000 |
| EBIT after 10.0% sales change | $960,000 |
| Pre-tax income after change | $780,000 |
A 10.0% change in sales changes pre-tax income by about 36.8%.
Interpreting the results
- High operating leverage comes from a large fixed-cost base; it magnifies both growth and decline.
- Combining high operating and high financial leverage compounds earnings volatility.
- Leverage measures apply near the current sales level; they change as sales move.
Frequently asked questions
What does a DOL of 3.0 mean?
A degree of operating leverage of 3.0 means operating income changes about three times as fast as sales. A 10% increase in sales raises operating income by roughly 30%, and a 10% decrease lowers it by roughly 30%.
What causes high operating leverage?
Operating leverage comes from fixed costs such as rent, salaried staff and depreciation. The larger the fixed-cost base relative to contribution margin, the higher the leverage and the more volatile operating income becomes.
How does financial leverage combine with operating leverage?
Financial leverage comes from fixed interest costs. The degree of total leverage equals operating leverage multiplied by financial leverage, measuring how a change in sales affects pre-tax earnings.
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