# Degree of operating leverage

Checked for updates, April 2022. Accountingverse.com

## Introduction

The degree of operating leverage (DOL) is used to measure sensitivity of a change in operating income resulting from change in sales.

Suppose the degree of operating leverage is 3.

A 10% increase in sales will result in a 30% increase in operating income. A 20% increase in sales will result in a 60% increase in operating income. Consequently it also applies to decreases, e.g., a 15% decrease in sales would result to a 45% decrease in operating income.

## Degree of Operating Leverage Formula

The degree of operating leverage (DOL) may be computed in two ways.

 DOL = Contribution margin Operating income

or

 DOL = % Change in operating income % Change in sales

Operating income is another term for EBIT (earnings before interest and taxes).

## Example

The following information pertains to last week's operations of XYZ Company. The company sold 2,500 units at \$25 each. Variable cost per unit is \$15.

 Sales Revenue \$62,500 Less: Variable Costs 37,500 Contribution Margin \$25,000 Less: Fixed Costs 15,000 Operating Income \$10,000

The degree of operating leverage is:

 DOL = Contribution margin Operating income = \$25,000 \$10,000 DOL = 2.5 times

Analysis: If sales revenue changes by a certain percentage, operating income will change by 2.5 times the percentage change in sales. A 10% increase in sales will result in a 25% increase in operating income.

 Old New Sales Revenue (\$25/unit) \$62,500 \$68,750 Less: Variable Costs (\$10/unit) 37,500 41,250 Contribution Margin \$25,000 \$27,500 Less: Fixed Costs 15,000 15,000 Operating Income \$10,000 \$12,500

In the table above, sales revenue increased by 10% (\$62,500 to \$68,750). However, it resulted in a 25% increase in operating income (\$10,000 to \$12,500).

This is actually caused by the "amplifying effect" of using fixed costs. Even if sales increase, fixed costs do not change, hence causing a larger change in operating income. This goes the same for decrease in sales. If sales revenues decrease, operating income will decrease at a much larger rate.

Key Takeaways

The DOL measures the how sensitive operating income (or EBIT) is to a change in sales revenue.

It basically answers the question: By how many times will operating profit increase or decrease in relation to the increase or decrease in sales?

For example, a DOL of 2 means that if sales increase (decrease) by 50%, operating income is expected to increase (decrease) by twice, i.e., 100%.

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