Degree of Operating Leverage (DOL)
Definition of Degree of Operating Leverage
The Degree of Operating Leverage (DOL) is the leverage ratio that sums up the effect of an amount of operating leverage on the company’s earnings before interests and taxes (EBIT). Operating Leverage takes into account the proportion of fixed costs to variable costs in the operations of a business. If the degree of operating leverage is high, it means that the earnings before interest and taxes would be unpredictable for the company, even if all the other factors remain the same.
Formula for determining Degree of Operating Leverage
The formula used for determining the Degree of Operating Leverage or DOL is as follows:
DOL = % Change in EBIT / % Change in Sales
The Degree of Operating Leverage Ratio helps a company in understanding the effects of operating leverage on the company’s probable earnings. It is also important in determining a suitable level of operating leverage which can be used in order to get the most out of the company’s Earnings before interest and taxes or EBIT.
If the operating leverage is high, then a smallest percentage change in sales can increase the net operating income. The net operating income is the amount of income that is left after payments of fixed cost are made, regardless of how much sales has been made. Since the Degree of Operating Leverage or DOL helps in determining how the change in sales volume would affect the profits of the company, it is important to ascertain the value of degree of operating leverage in order to minimize the losses to the company.
A business would benefit if the can estimate the Degree of Operating Leverage or DOL. The impact of the leverage on the percentage of sales can be quite striking if not taken seriously; therefore it is really important to minimize these risks of the business. If you get a higher degree of operating leverage or DOL then you should try and balance the operating leverage to balance with the financial leverage in order to provide with profits to the company. A company’s balance Degree of Operating Leverage can provide the financial leverage is an important factor contributing to business profits. Even a small percentage of increase in sales can help in having a greater proportion of profits in the company, so it is really important to maintain a balance between both financial leverage and operating leverage to yield maximum benefits.