Degree of Operating Leverage Formula (Table of Contents)
- Degree of Operating Leverage Formula
- Examples of Degree of Operating Leverage Formula (With Excel Template)
- Degree of Operating Leverage Formula Calculator
Degree of Operating Leverage Formula
The degree of operating leverage (i.e. DOL) is a type of multiple which measures how much the operating income (i.e. EBIT) of the firm will change in response to a change in sales. Companies or firms with a large or huge proportion of the fixed costs to the variable costs will be having higher levels of operating leverage.
The formula to calculate the degree of operating leverage is as follows:
where
- % Change in EBIT = (EBIT current year – EBIT previous year) / EBIT previous year
- % Change in Sales = (Sales current year – Sales previous year) / Sales previous year
Examples of Degree of Operating Leverage Formula (With Excel Template)
Let’s take an example to understand the calculation of the Degree of Operating Leverage formula in a better manner.
Degree of Operating Leverage Formula – Example #1
ABC Inc. has approached Tim, a financial analyst, as it wants to know the fluctuations in its operating income and revenue changes. Tim has recommended using the degree of operating leverage. Following details have been gathered by him from the financial statements of the company.
Solution:
% Change in EBIT is calculated using the formula given below
% Change in EBIT = (EBIT current year – EBIT previous year) / EBIT previous year
- % Change in EBIT = (28,716 – 26,448) / 26,448
- % Change in EBIT = 8.58%
% Change in Sales is calculated using the formula given below
% Change in Sales = (Sales current year – Sales previous year) / Sales previous year
- % Change in Sales = (111,264 – 104,930) / 104,930
- % Change in Sales = 6.04%
Degree of Operating Leverage is calculated using the formula given below
Degree of Operating Leverage = % Change in EBIT / % Change in Sales
- Degree of Operating Leverage = 8.58% / 6.04%
- Degree of Operating Leverage = 1.42
Degree of Operating Leverage Formula – Example #2
Following is an extract from the annual report of Exas Inc., you are required to calculate the degree of operating leverage.
Solution:
% Change in EBIT is calculated using the formula given below
% Change in EBIT = (EBIT current year – EBIT previous year) / EBIT previous year
- % Change in EBIT = ((-169,016) – (-159,068)) / (-159,068))
- % Change in EBIT = 6.25%
% Change in Sales is calculated using the formula given below
% Change in Sales = (Sales current year – Sales previous year) / Sales previous year
- % Change in Sales = (99,376 – 39,437) / 39,437
- % Change in Sales = 151.99%
Degree of Operating Leverage is calculated using the formula given below
Degree of Operating Leverage = % Change in EBIT / % Change in Sales
- Degree of Operating Leverage = 6.25% / 151.99%
- Degree of Operating Leverage = 0.04
Degree of Operating Leverage Formula – Example #3
Following is an extract from the annual report of Facebook Inc., you are required to calculate the degree of operating leverage for consecutive years.
Solution:
% Change in EBIT is calculated using the formula given below
% Change in EBIT = (EBIT current year – EBIT previous year) / EBIT previous year
For 2017-2018
- % Change in EBIT = (24,913,000 – 20,203,000) / 20,203,000
- % Change in EBIT = 23.31%
For 2015-2016
- % Change in EBIT = (12,427,000 – 6,225,000) / 6,225,000
- % Change in EBIT = 99.63%
% Change in Sales is calculated using the formula given below
% Change in Sales = (Sales current year – Sales previous year) / Sales previous year
For 2017-2018
- % Change in Sales = (55,838,000 – 40,653,000) / 40,653,000
- % Change in Sales = 37.35%
For 2015-2016
- % Change in Sales = (27,638,000- 17,928,000) / 17,928,000
- % Change in Sales = 54.16%
Degree of Operating Leverage is calculated using the formula given below
Degree of Operating Leverage = % Change in EBIT / % Change in Sales
For 2017-2018
- Degree of Operating Leverage = 23.31% / 37.35%
- Degree of Operating Leverage = 0.62
For 2015-2016
- Degree of Operating Leverage = 99.63% / 54.16%
- Degree of Operating Leverage = 1.84
Explanation
The formula for calculating the degree of operating leverage is divided into two parts, i.e. % change in operating income, and the second is the % change in revenue. The first part is changed in operating income as that is the key income part which determines which variables (i.e. expenses) are required to be done in order to operate that business and on the other hands, the second part represents the changes in sales which are nothing but changes in net revenue.
Relevance and Uses
The degree of operating leverage can depict the impact of operating leverage on the firm’s or the company’s earnings before interest and taxes (which is EBIT). Also, the DOL is key if one wants to assess the effect of the variable costs and the fixed costs of the core operations of the entity or of the business.
A high degree of operating leverage (DOL) does provide an indication that the entity or the company or the business might have a high proportion of fixed operating costs as compared to its operating costs that are variable in nature which could mean that the company is using more fixed assets to support its key business. It further would also mean that the entity or the company can make more money or earn more revenue from every additional sale while keeping the entity’s fixed costs intact. So, the company or the entity will have a high Degree of Leverage by making fewer sales with higher margins. As a result of that, fixed assets, like plant, property, and equipment, will acquire a higher value without incurring any additional higher costs. At the end of the day, the firm’s or the company’s profit margin may expand with the earnings that are increasing at a faster rate than its revenues.
On another hand, a low Degree of Operating Leverage which suggests that the entity or the company has a lower proportion of fixed operating costs as compared to its operating costs that are variable which would mean that it uses lesser fixed assets to support its key activities of the business while sustaining a low gross profit margin.
Degree of Operating Leverage Formula Calculator
You can use the following Degree of Operating Leverage Calculator
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