Answer
Operating leverage refers to the extent to which a company's costs are fixed versus variable. It is measured by the contribution margin, which is the difference between sales and variable costs. A high degree of operating leverage means a significant portion of costs is fixed, while a low degree indicates more variable costs.
Knowing the degree of operating leverage is helpful to managers because it helps them understand the impact of changes in sales volume on profitability. With high operating leverage, small changes in sales can lead to significant variations in profits, both positively and negatively. This knowledge assists managers in making informed decisions about pricing, cost structure, and resource allocation.
Work Step by Step
Operating leverage refers to the extent to which a company's costs are fixed versus variable. It is measured by the contribution margin, which is the difference between sales and variable costs. A high degree of operating leverage means a significant portion of costs is fixed, while a low degree indicates more variable costs.
Knowing the degree of operating leverage is helpful to managers because it helps them understand the impact of changes in sales volume on profitability. With high operating leverage, small changes in sales can lead to significant variations in profits, both positively and negatively. This knowledge assists managers in making informed decisions about pricing, cost structure, and resource allocation.
