Topic: Finance

Type of paper:	Essay
Subject area:	Finance
Academic level:	College
Style:	APA
Size:	31.5 kB
Word count:	550
Mark awarded:
Date submitted:	2010-01-06 05:02:17
Rating/Votes count:	n/a

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state, com, change, career, operating, finance, room, leverage, EBIT, Airbus, respond, Power Prepares, Power Plan, Running Head, Management Situations

Running Head : High Operating Leverage An overview of companies that would be expected to have a high degree
of operating leverage and the implications of such cost structures .
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Operating leverage describes the relationship between fixed assets and
variable costs and impacts the extent to which a change in sales will
impact the operating income . A company is said to have a high operating
leverage if its fixed costs are high in relation to their variable
costs . A high operating leverage can be both a positive and a negative
thing . When business is doing well and sales are increasing , companies
with a high operating leverage will see their Earnings Before Income Tax (EBIT ) increase at a higher exponential rate . However , if sales
decrease EBIT will decrease at a quicker rate than the drop in sales and
thus maintaining a high operating leverage can be a risky strategy as a
downturn in sales may entail that the company is unable to cover their
high fixed costs and may subsequently become unprofitable . Operating
leverage is therefore a key consideration for anyone evaluating the
financial performance of a company as it can assist to explain financial
performance , ``operating leverage magnifies results , making gains look
better and losses look worse (Schmedt , 1998 .
A high operating leverage can , in some circumstances , create additional
value . One example of a company that benefited from a high operating
leverage is Microsoft . Software companies typically have high operating
leverage as a result of the high fixed costs associated with research
and development . During the boom period of the 90s , Microsoft 's profits
grew at an average annual rate of 47 . This was almost 10 higher than
their sales growth of 38 (Marshall et al , 2003 , p435 . This
discrepancy can be explained by their operating leverage . Every sale
they made once they had passed their fixed costs contributed directly to
their bottom line , leading to inflated profits . Since high profits
attract investors and additional capital , high operating leverage was a
very positive thing for Microsoft during this period .
Oasis Airlines Hong Kong is an example of a company that was operating
with a high operating leverage . Their fixed costs were generated as the
result of the need for them to finance a great deal of their assets with
debt . Such debts needed to be repaid , leading to large amounts of fixed
costs . Although this situation is unavoidable for airlines due to the
costs associated with leasing and buying planes , it is not a positive
position to be in . Demand for airlines services is typically elastic
it will fluctuate according to economic conditions . Such changes in
demand will cause earnings fluctuations . For Oasis , their high
operating leverage entailed that they did not do particularly well
during recent downturn resulting in bankruptcy due to their failure to
cover their fixed costs . Other airlines that have been unable to survive
economic downturn due to their high operating level include Sabina and
Skybus Airlines . The airline...

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