Thread by @badola_arjun

What is Operating Leverage?

In very simple terms: Increase in revenue with no/less increase in cost.

Best way to understand operating leverage is by thinking of a tech company.

Let's assume Facebook buys 1 unit of server for which it can add 100,000 users and currently they have only 50,000 users.

Now, due to boost in demand their users double to 100,000 but their cost remain constant as their server already had the capacity to handle 100,000 users.

This was an example of a positive operating leverage.

Let's see what is the opposite of that.

What if their is sudden decrease in users to 25,000 users, will the cost fall? No.

Company would start to struggle as their revenues would have declined but not cost as they are fixed in nature here.

This is called negative operating leverage.

Let me give one more example which you might have seen in your day to day lives.

A taxi driver.

If he gets one ride or three/four his cost will remain same.

The day he gets three/four people positive operating leverage will kick in. (Regular ride: one person)

But if he gets only one person for a ride than his regular three/four people then negative operating leverage would kick in.

(Note the word regular here)

I made this thread because while starting out investing I used to get confused a lot by this term.

I hope this is a simplified version.

Please correct me if I have understood the concept wrong. :)