The power and pitfalls of operating leverage

Recently, Ultratech Cement , a prominent player in the cement industry, attributed its increase in operating margins to operating leverage. A 20 per cent increase in sales led to operating profit increasing by 42 per cent in Q4 FY23. But what exactly is operating leverage? Operating leverage measures how a company's profits react to changes in sales. Think of it like a seesaw: just like a seesaw tilts when one side is heavier than the other, a company's profits can also tilt based on how its costs (fixed and variable) and revenues are balanced. Let us explain. If a company has high fixed costs (a heavy side on the seesaw), it has high operating leverage. This can be good because when sales rise, profits soar faster because fixed costs remain constant. However, during periods when sales fall, profits can plummet by a greater magnitude as those fixed costs still need to be covered. Conversely, if a company has more var

This article was originally published on September 28, 2023.