Finance & Accounting
Definition
Operating leverage measures the proportion of fixed costs in a company's cost structure. High operating leverage means a large share of costs are fixed — so revenue increases translate into disproportionately large profit increases, but revenue declines are equally amplified.
Operating leverage is calculated as the ratio of fixed costs to total costs, or more precisely as the percentage change in operating income relative to the percentage change in revenue. A business with 80% fixed costs and 20% variable costs has high operating leverage. If revenue grows 10%, operating income might grow 25–30% because the fixed cost base is spread over more revenue. The inverse is also true: a 10% revenue decline hits operating income much harder. SaaS companies and manufacturers typically have high operating leverage — large upfront infrastructure costs but low marginal cost to serve additional customers. Consulting firms and service businesses have lower operating leverage because costs (primarily labor) scale with revenue. The Degree of Operating Leverage (DOL) formula: DOL = % Change in EBIT ÷ % Change in Revenue.
Understanding your operating leverage helps you model how different revenue scenarios affect profitability — and how much financial risk you're carrying. High operating leverage creates upside in growth but significant risk in downturns. A fractional CFO or financial advisor can help you build a financial model that shows your leverage ratio and stress-tests your business against revenue decline scenarios.