How is the degree of operating leverage (DOL) calculated?

The degree of operating leverage (DOL) quantifies how a change in sales volume will affect operating income. It represents the sensitivity of a company's operating profit to changes in sales. The correct formula for calculating DOL is derived from its definition and is expressed as:

DOL = 1 + (Fixed Costs / Operating Cash Flow).

In this formula, operating cash flow (OCF) is a crucial variable, representing the income generated from operations after accounting for variable costs but before financing costs and taxes. The inclusion of fixed costs in the formula illustrates how those costs amplify the impact of sales changes on operating income. When sales increase, fixed costs remain constant, leading to greater profit increases relative to the sales increase, thereby demonstrating higher operating leverage.

Understanding this relationship is important for businesses because it helps in assessing risk; a high DOL suggests that a small increase in sales can lead to substantial increases in operating profit, but it also indicates higher risk if sales decline.

The other options do not correctly reflect the means of calculating DOL. For instance, the first choice incorrectly combines operating cash flow and fixed costs without showing how they relate to sales changes, while the third option misrepresents costs. The fourth option simplifies the DOL calculation but misses the