Provide information that they may have missed or may not have considered in regard to operating leverage. A company's earnings can rise faster, as a percentage, than its revenue due to operating leverage, and operating leverage is due entirely to the fixed costs. Do you agree with your peers' findings? Why or why not?

Post 1:

One would assume that if a company's sales were to increase by "x dollars" that the earnings would also increase by the same "x dollars", however, in reviewing operating leverage this is deemed to not be accurate. Operating leverage can be defined as a company's fixed cost represented as a percentage of its total costs. The metric is used to evaluate the breakeven point, the number of units or sales needed to be produced in order to cover the costs incurred while producing said product, as well as project likely profit levels on individual sales. (Bragg, 2018). Companies with high fixed costs will normally have a high operating leverage as well, while companies with a low fixed costs will normally have a low operating leverage. A company with a high operating leverage means that company has a large percentage of fixed costs in relation to their overall costs, meaning the profit level is high on their sales, however, success is dependent on sustaining the level of sales to cover the large amount of fixed costs. On the other hand, a company with a low operating leverage has a large portion of their costs being variable costs, which means they vary with the sales activity volumes; having low fixed costs means the company can withstand a lower sales volume as they don't have the high fixed costs to overcome with sales to result in a positive operating income. Depending on the operating leverage, the impact on operating income from a change in sales differs- if a company has a high operating leverage, then a change in sales would result in a large change in operating income with a change in sales, and companies with a low operating leverage would show a small impact on operating income with changes in sales. (Warren, 2018).

Post 2:

This discussion is related to operating leverage. According to our text, operating leverage is the relationship of a company's contribution margin to its operating income. Thus, the formula to calculate operating leverage is: 

operating leverage = contribution margin/operating income 

 

In a high operating leverage situation, a large proportion of the company's costs are fixed costs, examples include telecommunications and pharmaceutical companies. High operating leverage makes a company more sensitive to changes in revenue. A limited revenue change will greatly change the profit since the fixed costs remain the same. The higher proportion of fixed costs means that the operating leverage is higher, and the company has more business risk. With high fixed costs, the percentage change in profits, when sales volume grows, is larger than the percentage change in sales. When the sales volume declines, the negative percentage change in profits is larger than the decline in sales. Operating leverage has huge benefits in good times when sales grow, but it significantly amplifies losses in bad times, resulting in a large business risk for a company. Even with a 12% increase in sales the contribution margin stays the same, and fixed costs have not changed. Because of the high degree of operating leverage, the increase in sales translates into a larger increase in its net operating income.