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The Power of Operating Leverage Determining variable and fixed costs leads us to our next discussion. Why bother studying these costs? To determine operating leverage To determine the company's ability to adapt to changing sales levels To find the break-even sales point. Degree of Operating Leverage The term \"operating leverage\" refers to fixed costs. Consider: High Fixed Costs = High Degree of Operating Leverage (HDOL) Low Fixed Costs = Low Degree of Operating Leverage (LDOL) Companies with high fixed costs versus variable costs have higher operating leverage. Why? Companies with a HDOL must reach a higher level of sales to cover fixed costs before profits can occur. Once sales exceed that level, profitability increases dramatically since variable expenses are much smaller than fixed costs (which have already been covered). On the other hand, companies with LDOL, will have lower fixed costs, but every dollar of sales will be chewed up by variable costs leaving a modest profit. Conclusion: Higher Leverage companies must have high level of sales compared with capacity, in order to cover all expenses (to reach breakeven). Why do lenders care about Operating Leverage? If companies with high operating leverage see a decline in sales, profits will be adversely impacted since it will be more difficult to cut expenses. Since debt service is in essence a \"fixed cost\