Degree of Operating Leverage (DOL)

What Is the Degree of Operating Leverage (DOL)?

The degree of operating leverage (DOL) is a different that measures how much the operating income of a company will change in response to a change in sales. Companies with a large extent of fixed costs (or costs that don't change with production) to variable costs (costs that change with production volume) have higher levels of operating leverage.

The DOL ratio helps analysts in deciding the impact of any change in sales on company earnings or profit.

Formula and Calculation of Degree of Operating Leverage

$\begin &DOL = \frac{$
There are a number of alternative ways of computing the DOL, each in light of the primary formula given previously:
$\text = \frac{\text}{\text}$

$\text = \frac{\text}{\text}$

$\text = \frac{\text{sales -- variable costs}}{\text{sales -- variable costs -- fixed costs}}$

$\text = \frac{\text}{\text}$

Everything the Degree of Operating Leverage Can Say to You

The higher the degree of operating leverage (DOL), the more sensitive a company's earnings before interest and taxes (EBIT) are to changes in sales, expecting any remaining variables stay steady. The DOL ratio assists analysts with figuring out what the impact of any change in sales will be on the company's earnings.

Operating leverage measures a company's fixed costs as a percentage of its total costs. It is utilized to assess a business' breakeven point — which is where sales are sufficiently high to pay for all costs, and the profit is zero. A company with high operating leverage has a large extent of fixed costs — and that means that a big increase in sales can lead to outsized changes in profits. A company with low operating leverage has a large extent of variable costs — and that means that it procures a more modest profit on every sale, except doesn't need to increase sales as much to cover its lower fixed costs.

Illustration of How to Use Degree of Operating Leverage

As a speculative model, say Company X has $500,000 in sales in year one and $600,000 in sales in year two. In year one, the company's operating expenses were $150,000, while in year two, the operating expenses were $175,000.
$\begin &\textEBIT = $500,000 - $150,000 = $350,000 \ &\textEBIT = $600,000 - $175,000 = $425,000 \ \end$
Then, the percentage change in the EBIT values and the percentage change in the sales figures are calculated as:
$\begin$
In conclusion, the DOL ratio is calculated as:
$\begin DOL &= \frac{$

The Difference Between Degree of Operating Leverage and Degree of Combined Leverage

The degree of combined leverage (DCL) expands the degree of operating leverage to get a more full image of a company's ability to produce profits from sales. It duplicates DOL by degrees of financial leverage (DFL) weighted by the ratio of %change in earnings per share (EPS) over %change in sales:

This ratio sums up the effects of consolidating financial and operating leverage, and what effect this combination, or varieties of this combination, has on the corporation's earnings. Not all corporations utilize both operating and financial leverage, yet this formula can be utilized assuming they do. A firm with a somewhat high level of combined leverage is viewed as less secure than a firm with less combined leverage since high leverage means more fixed costs to the firm.

Highlights

• A company with high operating leverage has a large extent of fixed costs, meaning a big increase in sales can lead to outsized changes in profits.
• The degree of operating leverage measures how much a company's operating income changes in response to a change in sales.
• The DOL ratio helps analysts in deciding the impact of any change in sales on company earnings.