Series 79: 3.2.8. Operating Leverage

3.2.8. Operating Leverage

Operating leverage is a distinct concept from “leverage” as introduced in Chapter 1 (and further discussed in the next section). Operating leverage is a measure of the degree to which fixed costs dominate a company’s cost structure. A company that has high operating leverage has high fixed costs and low variable costs. Fixed costs are assets such as property, plant, and equipment that don’t vary with the amount of sales. Variable costs are costs that increase with increasing sales. A company with higher operating leverage increases profit margins faster with increasing sales than a company with lower operating leverage.

Software companies, for example, tend to have high operating leverage because once software has been developed, it i