## Operating Leverage (OL)
### Meaning
Operating leverage measures the relationship between Sales and EBIT. It captures the tendency of operating income (EBIT) to change disproportionately with a change in sales volume. This disproportionate change is caused by fixed operating cost, which does not move with sales.
It is defined as the employment of an asset with a fixed cost so that enough revenue is generated to cover all fixed and variable costs. The use of assets carrying a fixed cost = operating leverage.
Operating leverage is a function of three factors: amount of fixed cost, variable contribution margin, and volume of sales.
### Formulas (DOL — all interchangeable with "OL")
1. $$DOL = \frac{\%\ Change\ in\ EBIT}{\%\ Change\ in\ Sales}$$
2. $$DOL = \frac{Contribution}{EBIT}$$
3. $$DOL = \frac{1}{Margin\ of\ Safety\,(\%)}$$
### Relationship: OL, Fixed Cost & Break-Even Point
| Operating Leverage | Fixed Cost | Break-Even Point |
|---|---|---|
| High OL | High fixed cost | Higher BEP |
| Low OL | Lower fixed cost | Lower BEP |
### Relationship: Margin of Safety & OL
MOS is the sales beyond breakeven. Higher MOS → lower business risk → higher profit. MOS is inversely related to OL (DOL = 1/MOS%).
| If MOS | Business Risk | DOL (1/MOS) |
|---|---|---|
| Rises | Falls | Falls |
| Falls | Rises | Rises |
### Analysis & Interpretation
| Situation | Result |
|---|---|
| No fixed cost | No operating leverage (OL = 1) |
| EBIT = 0 (sales at BEP) | OL undefined (OL = ∞) |
| EBIT > 0 (sales above BEP) | OL positive |
| EBIT < 0 (sales below BEP) | OL negative |
Note: DOL can never lie between 0 and 1. It is either ≤ 0 or ≥ 1.