MANAGEMENT

Detailed explanation-1: -Measuring Operating Leverage. Operating leverage occurs when a company has fixed costs that must be met regardless of sales volume. When the firm has fixed costs, the percentage change in profits due to changes in sales volume is greater than the percentage change in sales.

Detailed explanation-2: -When a company uses increased fixed cost for production, this is an example of operating leverage. Operating leverage is a cost-accounting formula that measures the degree to which a firm or project can increase operating income by increasing revenue.

Detailed explanation-3: -Some companies earn less profit on each sale but can have a lower sales volume and still generate enough to cover fixed costs. For example, a software business has greater fixed costs in developers’ salaries and lower variable costs in software sales. As such, the business has high operating leverage.

Detailed explanation-4: -Examples of fixed costs are rent and lease costs, salaries, utility bills, insurance, and loan repayments.

Detailed explanation-5: -Example 3: The variable cost per unit is $50 and the fixed operating costs are $50, 000 per year. The fixed interest expenses (non-operating) are $25, 000 and the firm has 10, 000 shares outstanding. Let us evaluate the combined leverage resulting from sale of 1) 2000 units & 2) 3000 units. Tax rate = 35%.