Potential and Real Operating Leverage

In this paper has been analysed the EBIT dynamic of a firm with high margins, strong revenues growth not paired by an adequate EBIT growth. The concept of the Degree of Operating Leverage developed by the economic literature was useful to highlight such a problem without explaining the root causes. Even standard income statement analyses cannot explain in depth such an unsatisfactory trend without turning to management accounting that was not available, like in many SMEs. The Author used some information coming from income statements, Revenues accounting and the discrimination between Variable and Fixed Costs to investigate the business case. He developed a method that throws light on EBIT dynamic between two financial periods in terms of quantity, mix, price and cost variations either managed or planned by the Top Management. The basic finding is that EBIT dynamic is explained by some parameters in period 1, the past period, and some variations in period 2, the current period. The link between such periods is the Degree of Operating Leverage, declined in an ex-ante measure, already given for the past period, and the variations of the current period that determines its ex-post measure. In this framework becomes immediately glaring how it is possible to find high margins coupled with inadequate EBIT growth and where the faults lie. In general, the method developed is very useful to understand the EBIT dynamic of any firm and to plan its future course more accurately.