The operating leverage can be calculated by using the following formula: Contribution Operating leverage Operating profit EBIT Contribution = Sales - Variable Cost. Operating profit means Earnings before Interest and Taxes (EBIT) Operating leverage is the ratio of net operating income before fixed charges to net operating income after fixed charges. Degree of Operating Leverage: The degree of operating leverage may be defined as a percentage change in the profits resulting from a percentage change in the sales. It can be put in the form of a formula as follows: DOL = Percentage change in net operating income Percentage change in sales 20 Operating leverage is directly proportional to business risk. It indicates the impact of change in sales on operating income. If a firm has a high degree of operating leverage a small change in sales will have a large effect on operating income. The operating profits of such a firm will increase at a faster rate than the increase in sales. Similarly, the operating profits of such a firm will suffer a greater loss as compared to reduction in its sales. Generally, the firms should not operate under conditions of a high degree of operating leverage because it is a very risky situation where a small decline in sales will affect its profits. A company produces and sells 10,000 calculators. The selling price per calculator is Rs. 500. Variable cost per calculator is Rs. 200 and fixed operating cost is Rs. 20, 00,000. You are required to calculate: (a) Operating leverage. (b) If sales are up by 10%, what is its impact on EBIT