When it comes to buying or selling a business, operating leverage can make or break the deal.
It shows how sensitive profits are to changes in sales.
At Elkridge Advisors, we help you understand these numbers and use them to your advantage.
What Is Operating Leverage
Operating leverage measures how revenue growth translates into profit growth.
A company with high operating leverage can increase profit faster when sales rise.
That is because fixed costs stay the same while revenue grows.
For example, imagine a software company that builds an app.
The main cost is development, which is paid once.
Every new customer adds revenue but very little extra cost. As sales grow, profits multiply quickly.
That is high operating leverage.
Now think of a catering business.
Every new event means more ingredients, staff, and time.
Costs grow with sales.
Profits increase slower.
That is low operating leverage.
Both models can succeed, but understanding which one you have is essential.
High leverage can create rapid profit growth, but also greater risk during downturns.
Low leverage offers stability but slower expansion.
Understanding this helps both buyers and sellers make better decisions.
Sellers can showcase efficiency and stability.
Buyers can spot growth potential and hidden risks before making an offer.
The Degree of Operating Leverage Explained
The degree of operating leverage (DOL) tells you how much your operating income changes when sales change.
It is a way to measure risk and reward.
A high DOL means profits rise quickly with sales increases but also fall sharply when sales drop.
A low DOL shows more stability but slower growth.
For example, if your DOL is 4, a 10 percent rise in sales can lead to a 40 percent rise in operating profit.
That looks great in good times, but during slow months, a 10 percent drop in sales could mean a 40 percent loss in profit.
Let’s take a coffee shop chain with heavy investment in rent and staff.
Those fixed costs make its DOL high.
When more customers come in, profits rise quickly since costs do not grow much.
But if customer traffic drops, profits fall sharply.
On the other hand, a freelance consultant with minimal fixed costs has a low DOL.
Income grows steadily with each new client, and risk is lower during quiet months.
Knowing your company’s DOL helps when planning an exit or evaluating a target company.
It reveals how well your operations handle change and helps you balance profit potential against risk.
The Degree of Operating Leverage Formula
The degree of operating leverage formula is simple:
DOL = Percentage change in EBIT / Percentage change in Sales
EBIT means earnings before interest and taxes.
This formula helps you see how sales fluctuations affect operating income.
Buyers use it to predict future performance.
Sellers use it to highlight the strength of their profit model.
Let’s look at an example:
Suppose your company’s sales grow by 10 percent, and your EBIT increases by 30 percent.
The DOL would be 3.
This means for every 1 percent change in sales, EBIT changes by 3 percent. That shows high sensitivity and strong profit potential.
Now consider another business where a 10 percent increase in sales only raises EBIT by 5 percent.
The DOL is 0.5, meaning the business grows steadily but with limited acceleration. It also faces less risk if sales fall.
Understanding this ratio helps investors and owners identify how efficiently a company converts sales into operating profit.
It also helps them compare potential targets or prepare their own company for sale.
When you understand this ratio, you can negotiate better, plan smarter, and identify where to strengthen your cost structure.
Why Operating Leverage Matters When Buying a Business
Operating leverage reveals how efficiently a company turns revenue into profit.
Buyers can use it to evaluate scalability and financial risk.
A company with strong operating leverage can deliver impressive profit growth once sales rise.
It also shows where the cost structure might limit expansion.
Understanding this helps buyers spot businesses that can scale quickly once fixed costs are covered.
For example, imagine a digital marketing agency.
It already pays for staff, tools, and software, which are mostly fixed costs.
When it wins more clients, profits grow faster than expenses.
That means high operating leverage and strong growth potential.
Now picture a logistics company.
Each new contract requires more drivers, fuel, and maintenance.
Costs grow in line with sales.
Profit margins stay steady.
That is low operating leverage, offering stability but limited upside.
Another example is a subscription-based business.
After the initial setup, every new subscriber adds mostly profit, not cost.
Investors love this model because it scales efficiently and builds recurring revenue.
This insight can be the difference between overpaying and securing a high-performing asset.
It allows buyers to see past surface-level earnings and understand how the business truly operates.
Why Operating Leverage Matters When Selling a Business
If you are selling, understanding your operating leverage helps you position your company as a high-margin, scalable opportunity.
Buyers love businesses that can grow profits faster than costs.
Highlighting this can increase valuation and strengthen your negotiation power.
For example, imagine a SaaS company that already built its platform.
Its fixed costs remain steady while each new user brings mostly profit.
Showing this structure can make investors eager to pay a premium.
Or think of an online education business.
Once the courses are created, adding more students costs almost nothing.
Profit margins rise quickly as enrollment grows.
A seller who presents this clearly can attract multiple buyers willing to compete for the deal.
Even a retail store can benefit. If it recently introduced automation or streamlined its logistics, it can demonstrate stronger leverage by proving how the same costs now support higher sales volumes.
At Elkridge Advisors, we help sellers refine their financial presentation to show the true power of their model.
We focus on numbers that investors understand and value most, turning operating data into persuasive deal stories.
Final Thoughts
Operating leverage is more than a number.
It is a powerful tool for understanding how your business performs and scales.
It shows how well your cost structure supports growth and how efficiently your team turns effort into profit.
For investors, it reveals hidden potential in companies that might look average at first glance.
For owners preparing to sell, it can transform the story behind their financials and justify a higher valuation.
At Elkridge Advisors, we have seen how two businesses with similar revenue can be valued very differently based on their operating leverage.
The company with better leverage often attracts stronger offers, faster negotiations, and more confident buyers.
Operating leverage also helps in planning future strategies.
It tells you when to invest in automation, when to scale sales teams, and when to reduce costs.
Knowing this gives both buyers and sellers a real edge in any transaction.
Elkridge Advisors combines financial expertise with hands-on M&A experience.
We help clients uncover leverage in their operations, highlight it during negotiations, and use it to build lasting value.
