Operating leverage is the term used to describe the reaction of net income when there is a change in sales volume. It can be a double-edged sword for companies, because if the company has high fixed costs in comparison to its variable costs, any increases in sales can dramatically increase the company's profits, since it is able to spread those fixed costs over more units produced and sold. The drawback comes when sales decrease, because then there is a smaller amount of units produced and sold that must now bear the fixed costs on top of the variable costs. The degree of operating leverage can be used to measure the volatility of earnings for a company, and also to compare that factor to other companies. To calculate it, you divide the contribution margin by net income. Management can also use the degree of operating leverage to calculate how net income will react when there is an increase/decrease in sales by multiplying the degree of operating leverage by whatever percentage of change management chooses, such as a 5% (multiply by 5% or .05) to calculate net income at a 5% decrease in sales. This can help when facing economic situations that management predicts will cause changes in sales volume.

Has anyone experienced this situation at work?

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