The firm’s ability to use operating cost to magnify the effects of changes in sales on its EBIT.
The degree of operating leverage may be defined as the change in the percentage of EBIT, for a given change in percentage of sales revenue.
Symbolically… When the data is given only for one year, then we have to compute operating leverage, by the following formula. Percentage change in Sales Or Percentage change in EBIT = Degree of Operating Leverage (DOL) Operating Profit (EBIT) Contribution = Operating Leverage
The percentage change in EPS due to the percentage changes in sales.
Or % Change in Sales % Change in EBIT % Change in Sales % Change in EPS = % Change in EPS X % Change in EBIT EBT EBT EBIT Contribution = EBIT X Contribution
Effect of Leverage… This combination is an ideal situation. The company can follow aggressive debt policy. High Low This combination have adverse effects of operating leverage were taken care of by having low financial leverage. Low High This combination is very cautious policy and not assuming risk. Low Low This combination is very dangerous policy, which should be avoided. High High Combined Effect Financial Leverage Operating Leverage