How to Calculate Degree of Operating Leverage

Calculate DOL

Simply put, the degree of operating leverage (DOL) is a measure of how sensitive operating income is to changes in sales. The ratio looks at asset utilization for insight into income potential by showing what effect changing the level of operating leverage will have over potential earnings.The ratio is also used to determine a maximum level of earnings before interest, taxes and amortization (EBIT).

Things You'll Need

• Spreadsheet or calculator

Instructions

1. Review the formula. The formula for DOL is "contribution margin" divided by "net operating income."

2. Determine contribution margin. The contribution margin is sales minus variable expenses. If a firm has $100,000 in sales and spends $10,000 on variable expenses (expenses determined by level of sales volume), the contribution margin amount is $90,000, or 90 percent. That is, 90 percent of sales contributed to gross margin.

3. Determine net operating income. Net operating income is the amount of income left after paying for all fixed costs out of gross margin; these are costs paid regardless of sales volumes. Examples include rents and utilities. Continuing with the example, if fixed costs were $40,000, my net operating income is: $100,000 (sales) minus $10,000 (variable costs) minus $40,000 (fixed costs) = $50,000.

4. Calculate operating leverage by dividing contribution margin by net operating income. Contribution margin amount is $90,000 and net operating income is $50,000. The DOL is: $90,000 divided by $50,000 = 1.8.

5. Interpret results. In general, a higher DOL is better, but it must be compared against other companies in the same industry. A company can increase its DOL by reducing costs.

References

• Investopedia: Degree of Operating Leverage

Resources

• Read this Article in Spanish