Operating Leverage

When a company has high fixed costs, a rise in sales can make profits jump much faster than revenue. That is operating leverage, and it works in reverse too. Here is how it works with simple numbers and a real example.

Fixed vs. variable costs

Some costs rise with every sale, like materials and shipping. Those are variable costs. Others stay about the same no matter how much the company sells, like factories, research teams and software development. Those are fixed costs.

A business with mostly fixed costs has high operating leverage. Once sales cover the fixed costs, most of each extra dollar of sales drops to profit.

An income statement: revenue at the top, costs in the middle, profit at the bottom.

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