operating leverage
The degree to which a company uses fixed costs in its operations. High operating leverage means small revenue increases produce large profit increases — and vice versa.
Example
“The airline's high operating leverage meant that a 10% revenue increase from fuller planes drove a 40% increase in operating profit.”
Memory Tip
High operating LEVERAGE = fixed costs amplify profits AND losses. Great in good times, brutal in bad.
Why It Matters
Understanding operating leverage helps you evaluate the stability and risk of companies you invest in or work for. A business with high operating leverage can grow profits quickly during good times, but it also faces greater losses when revenue drops, which directly affects your investment returns and job security.
Common Misconception
Many people think operating leverage is always good because it amplifies profits, but this ignores the downside risk. High operating leverage can turn small revenue declines into severe losses, making a company more vulnerable during economic downturns or industry disruptions.
In Practice
A software company with mostly fixed costs like salaries and server fees might generate 50 percent profit margins once it reaches scale. If revenue grows from 10 million to 12 million dollars, profit could jump from 2 million to 4 million dollars because those fixed costs stay the same. However, if revenue drops to 8 million dollars instead, profit plummets to just 1 million dollars, demonstrating how the same leverage works in both directions.
Etymology
OPERATING (from business operations) LEVERAGE (amplification through fixed costs). Fixed costs LEVERAGE (amplify) operating results.
Common Misspellings
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Related Terms
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See Also
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