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.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
-
Ofgem energy price cap to rise by 2% from OctoberGas and electricity bills are set to increase in the final quarter of 2025 for millions of people on the energy price cap
-
73% of savers plan to rely on partner’s pension in retirementA new survey suggests the majority of people may lack financial independence in retirement, with almost three-quarters set to rely on their partner’s pension
