Q:

How do you calculate operating leverage?

A:

Quick Answer

To calculate a company's operating leverage, take the company's sales and subtract its variable expenses, then take the resulting number and divide it by the company's net operating income. The resulting number will determine the fixed costs of the company as a percentage of the company's total costs, according to AccountingTools.

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Full Answer

The operating leverage of a company is a way to determine the value of fixed costs and variable costs. If a company has a high operating leverage, it means that the majority of costs to the company are fixed costs. This means that the company must have a high volume of sales to make up for all of the fixed costs every quarter.

Alternatively, if a company has low operating leverage, then the majority of its costs are variable costs, which means that these costs are only present in the event of a sale. These companies can make high profit at a low sales levels, as suggested by AccountingTools.

Calculating the operating leverage of a company requires the use of the company's contribution margin. The contribution margin of an entity is the variable costs subtracted by the total sales. Once the contribution margin is known, divide it by the company's net operating income to determine the overall operating leverage; this will be a number somewhere between 0 and 100.

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