Operating Leverage: A New Dimension

Abstract

Hitherto, in determining Operating Leverage, it is assumed that selling price does not vary with changing price of goods, thus inherently violating the Law of Demand, where price and quantity are inversely proportional to each other. This paper presents the sensitivity of Operating profits to simultaneous change in selling price and quantity of goods sold and formulates functions referred to as Price Leverage – which serves as a measure for the impact of changes in selling price on the operating profit and Total Operating Leverage – which serves as a measure for the combined impact of simultaneous change in selling price and quantity of goods sold. Further, the paper presents the application of concepts of Price Elasticity of Demand to sensitivity of operating profits, for determination of Break-even Point (BEP) and Optimum Capacity Utilization (or the level of Profit Maximization).

Keywords: Operating Leverage, Price Elasticity of Demand, Break-even Point, Optimum Capacity Utilization, Sensitivity Analysis