Operating Leverage
Candlefocus EditorThe break-even point refers to the point where a company’s total revenue is equal to its total expenses. When a company has a high level of operating leverage, it needs to cover a larger amount of fixed costs each month regardless of whether it sells any units of product. Conversely, a business with low-operating-leverage has high costs that vary directly with their sales but have lower fixed costs to cover each month.
Generally, the higher the operating leverage of the company, the larger the potential profits and losses when compared to other firms in the same industry. This is because when sales increase, the profits skyrocketed due to large fixed costs. While this can be beneficial when sales are increasing, it can also be detrimental as profits plummet when sales decrease.
Using operating leverage can also help businesses set the right prices for their products. This is because it helps identify when the price of a product or service should be set at the break-even point. This enables a business to cover all their costs and generate a profit.
In conclusion, operating leverage is an important tool to help companies understand the amount of fixed costs they must cover, as well as their break-even point. Knowing this information helps businesses set the right prices and maximize profits.