What does operating leverage measure?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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In business, the term "leverage" refers to the amount of debt that a firm has.  The term refers to the idea that the firm is using the debt as a lever to allow it to use a little debt to make large profits.

Operating leverage is a measure of how much of a firm's costs are fixed, as opposed to variable.  A firm has higher operating leverage if many of its costs are fixed.  Fixed costs are costs like machinery--things that cost a certain amount, regardless of how much product a firm produces.  A firm with high operating leverage is in a relatively good position because any increases in its level of production bring it more profits because so many of its costs are fixed.

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