Operating leverage measures the sensitivity of:

Question

Accepted Answer

Operating income to changes in sales. Operating leverage measures the sensitivity of operating income (EBIT) to changes in sales revenue. A company with high fixed costs relative to variable costs has high operating leverage, meaning a small percentage change in sales produces a larger percentage change in operating income - amplifying both gains and losses.

Sensitivity of net income to interest rates describes financial risk or interest rate risk, not operating leverage. Operating leverage deals with the cost structure of operations, not financing costs. Sensitivity of stock price to earnings changes relates to the price-earnings relationship or earnings multiplier effect, not operating leverage specifically. Sensitivity of cash flow to working capital changes describes working capital management dynamics, an entirely different area of financial analysis.

Operating leverage is an important concept on the DSST exam that connects to break-even analysis and business risk. Companies with high operating leverage (like airlines or manufacturing firms with expensive equipment) have higher break-even points but greater profit potential once break-even is exceeded. Understanding the degree of operating leverage (DOL = % change in EBIT / % change in sales) helps in assessing business risk.

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