Operating Leverage: What it is and why it’s an important KPI

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Operating leverage is the ratio of annual sales growth percentage to overhead growth percentage.

Say that you grow your revenues by 10% in a given year and your overhead expense grows at the same rate. That is a 1-1 ratio and indicates no operating leverage at all.

In my “best in class” world, that would be considered poor performance.

On the other hand, if revenues grow 10% and overhead grew at 5%, that would be considered very good performance. Let’s go a little deeper on this subject.

Overhead as an investment

There are two types of overhead, variable and fixed.

(Although this is debatable. I believe almost all overhead is variable.)

If you really look at it critically, overhead is an investment in which you expect a return. If you invest $1 in overhead and only get $1 back in revenue growth, most would not be satisfied. However, if you invest $1 in overhead and get $2 back in revenue, most would consider that a worthy investment.

You get operating leverage when people and processes are optimized efficiently.

Some would say this is not a KPI. I say measure everything, including operating leverage.

What is an ideal goal for operating leverage?

I think it to be variable based on the business, but I always wanted better than a 2-1 ratio of revenue growth percent to overhead growth percent.

The point is that every business should consider operating leverage and set a goal to manage toward.

Yes, obtaining operating leverage requires management skill, but achieving the goal obviously means greater EBITDA growth, a very good thing.

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