Degree of Operating Leverage

Accounting 525

Degree of Operating Leverage

[restricted to I > 0 which condition implies CM > F equivalently R > V + F]

NOTATION:

Total
revenue/price
variable cost
fixed cost
contribution margin

R
V
F
CM

quantity
income

Per Unit
p
v
f
cm

Q
I

1
i

BASIC RELATIONSHIPS:
R=p*Q
V=v*Q
CM = R - V
cm = p - v
CMR = cmr = CM / R = cm / p

CM = Q * cm

DEGREE OF OPERATING LEVERAGE:

DOL = CM / I
% INCOME CHANGE = DOL * % REVENUE CHANGE
PROOF:

subscript denotes the new level of operations

subscript

denotes the base or old level of operations

DOL must be calculated for the base level of operations and percentage changes
are calculated from the base level of operations [the denominator is the base level amount]

DOL =

to prove:

NOTE:

1/9/2014

CM / I

% INCOME CHANGE =

[ I - I ] / I

% REVENUE CHANGE =

[ R - R ] / R

% CONTRIBUTION MARGIN CHANGE =

[ CM - CM ] / CM

[ I - I ] / =I

CM / I

[ R - R ] / R

% R CHANGE = % CM CHANGE

[ R - R ] / R

[ CM - CM ] / CM

[ [ p * Q ] - [ p * Q ] ] / p * Q

[ [ p * Q ] - [ v + Q ] ] - [ [ p * Q ] - [ v * Q ] ] / [ [ p * Q ] - [ v * Q ] ]

[ p * [ Q - Q ] ] / p * Q

[ [ [ p - v ] * Q ] - [ [ p - v ] *Q ] ] / [ [ p - v ] * Q ]

[ Q - Q ] / Q

[ [ p - v ] * [ Q- Q ] ] / [ [ p - v ] * Q ]

[ Q - Q ] / Q

[ Q - Q ] / Q

[ I - I ] / I

CM / I

I - I

CM - CM

CM - F

CM - F

proven

[ CM - CM ] / CM

[ CM - F ] - [ CM - F ]

CM - CM

CM - F - CM + F

CM - CM

CM - CM

CM - CM proven

page 1

Degree of Operating Leverage

EXAMPLE INCOME STATEMENT:

Old

New

change $

R
V
CM
F
I

100
30
70
50
20

120
36
84
50
34

DOL

3.5 2.47059

change %

20
6
14
0
14

20.0000%
20.0000%
20.0000%

70.0000%

INTERESTING OBSERVATIONS
same revenue, same cost, same income, different DOL
summary level

firm A

E=V+F

firm B

100
80
20

R
E
I

detail level

firm A

R
V
CM
F
I
DOL

100
80
20
firm B

extremes

extremes

for I = 20

for I = 20

breakeven breakeven
firm A

100
20
80
60
20

100
50
50
30
20

100
0
100
80
20

100
80
20
0
20

2.5

75
15
60
60
0

firm B

60
30
30
30
0

firm A

R
V
CM
F
I

100
20
80
60
20

120
24
96
60
36

20
4
16
0
16

20.0000%

100
50
50
30
20

120
60
60
30
30

20
10
10
0
10

20.0000%

20.0000%
20.0000%

80.0000%

firm B

R
V
CM
F
I

1/9/2014

20.0000%
20.0000%

50.0000%

page 2

Degree of Operating Leverage

extreme cases: all variable cost firm, all fixed cost firm
all variable cost firm

100
80
20
0
20

R
V
CM
F
I

120
96
24
0
24

20
16
4
0
4

20.0000%

120
0
120
80
40

20
0
20
0
20

20.0000%

20.0000%
20.0000%

20.0000%

DOL
all fixed cost firm

100
0
100
80
20

R
V
CM
F
I

0.0000%
20.0000%

100.0000%

DOL

1<=
DOL
I/I <=
DOL
CM = I; F = 0

in general:
with R and I held constant [so C = V + F constant]
cost structure variations in v and F

<
< R/I
CM = R; V = 0

with CM held constant, as F increases, DOL increases

DOL
CM / I
CM / I

CM / I
CM / [ CM - F ]
1 / [ 1 - [ F / CM ] ]

=
=
=

more profitable firm has lower DOL

less profitable firm

R
V
CM
F
I

100
30
70
50
20

DOL

3.5

120
36
84
50
34

20
6
14
0
14

20.0000%

20
4
16
0
16

20.0000%

20
6
14
0
14

20.0000%

20.0000%
20.0000%

70.0000%

more profitable firm [more efficient operation]

R
V
CM
F
I
DOL

100
20
80
50
30

120
24
96
50
46

20.0000%
20.0000%

53.3333%

2.666667

more profitable firm [less expensive facilities]

R
V
CM
F
I
DOL

1/9/2014

100
30
70
40
30

120
36
84
40
44

20.0000%
20.0000%

46.6667%

2.333333

page 3

Degree of Operating Leverage

same percentage change or same revenue dollar amount

change from the new level is based on a new DOL
original base level, 20% change, $20 change

R
V
CM
F
I

100
30
70
50
20

DOL

3.5

120
36
84
50
34

20
6
14
0
14

20.0000%

24
7.2
16.8
0
16.8

20.0000%

20
6
14
0
14

16.6667%

20.0000%
20.0000%

70.0000%

new base level, same percentage change [20%]

R
V
CM
F
I
DOL

120
36
84
50
34

144
43.2
100.8
50
50.8

20.0000%
20.0000%

49.4118%

2.470588

new base level, same dollar amount change [$20]

R
V
CM
F
I
DOL

1/9/2014

120
36
84
50
34

140
42
98
50
48

16.6667%
16.6667%

41.1765%

2.470588

page 4