What do banks, airlines and hotels have in common? The answer is high operating leverage (also known as operating gearing). This means that fixed costs (predominantly property and staff) are a high proportion of total costs in the profit and loss account. As a result, profits are highly sensitive to changes in sales compared to another business with much lower leverage.
Say a firm has £100 of sales (or, 'turnover') £80 of fixed costs and £10 of variable costs; profit is £10 (100-80-10).Operating leverage is a substantial 89% (80 as a proportion of 90). If sales rise the following year by just 10% to £110, fixed costs remain constant and variable costs also rise by 10% to £11 the new profit figure is £19 (110-80-11), a huge rise of 90%. Conversely had sales declined suddenly by 10%, profits would have been wiped out.
In an economic downturn firms with high operational leverage, like banks, have to react very quickly, often by dumping staff, to stay alive.
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