Preparing for IPO: Understanding Operating Leverage

The best way to explain a financial concept.. is through practical examples! eg. Operating Leverage - Indian Hotels If you want to see Operating Leverage in action Check out the results of Indian Hotels FY19 - Sales: INR 4512 Crore - EBITDA: INR 830 crore - PAT: INR 296 crore - EBITDA Margin: 18% FY24 - Sales: INR 6769 Crore - EBITDA: INR 2160 crore - PAT: INR 1330 crore - EBITDA Margin: 32% Over 5 years - Sales growth 50% - EBITDA growth 160% - PAT growth 350% Infact, latest quarter EBITDA Margin is 38%!! Operating leverage is the magnified movement in operating profits with a relatively smaller movement in sales. Anything with a large fixed cost structure, and a play on capacity utilization, will exhibit this. Hotels are classic examples. Since costs are largely fixed, as utilization improves, or sales increase, the movement in profits is larger. Of course it is a double edged sword as well. A downturn in sales is equally bad! A 20% dip in sales could result in much larger drop in profits. If you are an analyst or an investor, keep these business cycle movements in mind.. ---- Peeyush Chitlangia, CFA I help you decode complex financial concepts

We looked at over 100+ deals before eventually finding and acquiring our cornerstone business, East West Engineering. What did we like about it? Well, many things - but there was one financial aspect that I LOVED. It was this... The company had grown Sales at 8% CAGR over the past 4 years - but EBITDA grew nearly 3x faster at a 23% CAGR. It signalled to me that the business had a feature I actively look for. 𝗢𝗽𝗲𝗿𝗮𝘁𝗶𝗼𝗻𝗮𝗹 𝗹𝗲𝘃𝗲𝗿𝗮𝗴𝗲. It's kind of a business cheat code. Here's what it means and why it matters👇 Operational leverage means growing revenue without a proportional increase in fixed costs. As sales rise, expenses like rent, equipment, and admin stay relatively flat. This boosts profitability as the business scales. For example: If revenue grows by $1M but fixed costs remain the same, the incremental gross profit mostly flows straight to profit (EBITDA). This is why EBITDA growth can outpace revenue significantly. Operational leverage magnifies earnings when you have: ✅High and sustainable gross margins ✅Stable fixed cost base ✅ Efficient cost control as you scale This matters because investors and finance dorks like me LOVE operational leverage. It signals: ✅Business scalability ✅Margin expansion potential ✅Higher returns on incremental sales Growth isn't just about revenue - how efficiently you grow matters more. Look for businesses with operational leverage.

This is a simple way to understand potential operating leverage. Sometimes companies build capacity much ahead of demand. In the beginning, this makes utilization look very low. But that is exactly where operating leverage starts building. Take the example of Milky Mist. When the company expanded, the management planned 5–10 years ahead and created capacity even if it meant low utilization initially. In FY25: 📍 Ice cream plant utilization was only 19% 📍 Chocolate plant utilization was only 10% At first glance, this might look inefficient. But look at the potential: 📍 Ice cream capacity can support ~₹900 crore revenue, while current revenue is ~₹200 crore. 📍 Paneer capacity can support ~₹2,000 crore revenue, while current revenue is ~₹900 crore. Once demand increases, the same factories can produce much more without a big increase in fixed costs. That’s when operating leverage kicks in and margins expand. But there’s an important point to remember. Having spare capacity does not automatically guarantee operating leverage. What really matters is when the demand comes and whether that demand is profitable. If a company starts running plants just to improve utilization and ends up cutting prices to fill capacity, the expected operating leverage may disappear. So while analyzing companies, don’t just ask: “How much capacity do they have?” Also ask: “Will future demand be strong enough and profitable enough to absorb this capacity?” That’s where the real operating leverage lies. Follow Nikhil Singh to stay updated with more such interesting content and insights.

Investment Banking: Operating Leverage Explained (Free Excel Download) 🏆 What is Operating Leverage? Operating leverage refers to the degree to which a company can use fixed costs to generate greater profits as sales increase. Fixed costs do not vary with activity levels, while variable costs change directly according to activity levels. Companies with high operating leverage have a higher proportion of fixed costs in their total cost structure. Which means beyond the breakeven volume, a small increase in sales can lead to a significant increase in operating income, which in turn will increase operating margin. In contrast, companies with low operating leverage rely more on variable costs. Which means that any change in revenue will have a similar impact on operating profit, so their operating margin is less sensitive to changes in sales. How Does It Work? To understand how operating leverage works, it’s essential to grasp the difference between fixed and variable costs: Fixed Costs: These are expenses that do not change with the level of production or sales. So if a company sells 10% more product than the previous quarter, its fixed costs will be unchanged compared with the previous quarter. Variable Costs: These costs vary directly with the level of production or sales. So if a company sells 10% more product than the previous quarter, its variable costs will also increase by 10% compared with the previous quarter. While the exact details of fixed and variable costs can be determined through cost accounting, this information is typically not available in public disclosures. However, financial accounting offers close proxies: the cost of goods sold (COGS) is usually variable, while selling, general & administrative (SG&A) costs are generally fixed. Depreciation and amortization are also major fixed costs. These figures are readily available in annual and quarterly filings. How Is It Calculated? Operating leverage can be quantified and is also known as Degree of Operating Leverage (DOL). The DOL quantifies the sensitivity of a company’s operating income to changes in sales volume. It is a ratio that measures the percentage change in operating income for a given percentage change in sales. DOL = %∆ in Operating Income / %∆ in Revenue Alternatively, DOL can be calculated as below: DOL = Contribution Margin / Contribution Margin - Fixed Costs Where the Contribution Margin is Revenue minus Variable Cost. Key Learning Points: • Operating leverage measures a company’s ability to use fixed costs to increase profits as sales grow • High operating leverage involves substantial fixed costs, significantly boosting profits once these costs are covered • High operating leverage indicates potential for significant profit increases with sales growth but also higher risk during downturns Download our free Operating Leverage excel workout below👇

Operating Leverage: The Critical Profit Multiplier in Hospitality Degree of Operating Leverage (DOL) quantifies how operating income responds to revenue changes - critical for understanding profit volatility and valuation impact. DOL Formulas: 1. Standard: DOL = (% Change in EBITDA) ÷ (% Change in Revenue) 2. Quick: DOL = Contribution Margin ÷ EBITDA Working Example (INR): Hotel with ₹200 Cr Revenue: • Revenue: ₹200 Cr • Variable Costs: ₹56 Cr (28%) • Contribution Margin: ₹144 Cr • Fixed Costs: ₹74 Cr • EBITDA: ₹70 Cr (35%) DOL = ₹144 Cr ÷ ₹70 Cr = 2.06 DOL Impact Analysis: 20% Revenue Increase Scenario: • New Revenue: ₹240 Cr (+₹40 Cr) • New Variable Costs: ₹67.2 Cr (+₹11.2 Cr) • Additional Contribution: ₹28.8 Cr • New EBITDA: ₹98.8 Cr (+₹28.8 Cr = +41.2%) • Formula Check: 20% × 2.06 = 41.2% ✓ 20% Revenue Decrease Scenario: • New Revenue: ₹160 Cr (-₹40 Cr) • New Variable Costs: ₹44.8 Cr (-₹11.2 Cr) • Reduced Contribution: ₹28.8 Cr • New EBITDA: ₹41.2 Cr (-₹28.8 Cr = -41.2%) • Formula Check: 20% × 2.06 = 41.2% ✓ Stakeholder Implications: Asset Managers: DOL 2.06 offers balanced risk-reward. Revenue strategies directly impact asset value creation. Operators: Fixed cost optimization critical - every rupee saved flows directly to EBITDA with 2x amplification effect. Owners: Moderate leverage provides growth upside while maintaining downside protection for sustainable returns. Valuation Impact: • Higher Valuations: DOL 2.0-3.0 commands superior multiples due to scalable profit structure • Risk Pricing: Higher DOL requires adjusted cap rates reflecting earnings volatility • Exit Strategy: Optimal DOL range maximizes both operational performance and sale valuations Bottom Line: Understanding DOL transforms revenue management from tactical to strategic - every percentage point of revenue directly multiplies profit impact. Want to change the game? Excelsior Asset Management has the expertise to optimize your property’s operating leverage, understanding that every business has unique constraints, drivers, and motivations. Article by Vikram Aditya Singh Vikram A. Singh AEHL #Hospitality #HotelFinance #OperatingLeverage #AssetManagement #RevenueManagement #ExcelsiorAssetManagement

Ever notice how a small change in sales can swing your operating profit wildly? That’s operational leverage at work — and it’s one of the most underrated insights in FP&A. Operational leverage measures how sensitive your operating profit is to changes in sales. It tells you how much profit growth (or decline) you can expect for a given change in revenue — and Excel makes this analysis simple. Here’s the basic formula: Operational Leverage = % Change in Operating Profit / % Change in Sales Let’s put it into action. Suppose you have: ◽ Sales in Year 1: $10,000,000 ◽ Sales in Year 2: $11,000,000 ◽ Operating Profit in Year 1: $1,500,000 ◽ Operating Profit in Year 2: $1,950,000 In Excel: = ( (1950000 - 1500000) / 1500000 ) / ( (11000000 - 10000000) / 10000000 ) Result → 3.0 That means for every 1% change in sales, profit changes by 3%. Use operational leverage to: 🔹 Identify profit sensitivity in budget scenarios 🔹 Stress-test forecasts for volume or price swings 🔹 Compare business units with different cost structures 🔹 Communicate risk/reward in board discussions High leverage = high risk and high reward. Low leverage = more stable but slower profit growth. How often do you analyze operational leverage as part of your forecast or sensitivity models? Is it a standard step — or something you only do when margins start moving? If you’re looking to make your Excel models explain why profits move (not just that they move), I share weekly FP&A modeling insights right here on LinkedIn. Follow along for practical, finance-focused Excel techniques.

Every business owner wants to grow revenue. But not every dollar of revenue hits the bottom line the same way. The difference comes down to a finance term called "operating leverage." It's a calculation most business owners in the $2-20M range have never run, and it should be on your radar quarterly. Operating leverage is how sensitive your profits are to changes in revenue. If a small increase in sales leads to a big jump in profit, you have high operating leverage. If profits move roughly in line with sales, you have low operating leverage. What drives it is your cost structure. The more your costs are fixed (salaries, rent, software, insurance), the more operating leverage you have. Those costs usually stay the same whether revenue goes up or down. So, when revenue climbs, more of each new dollar flows straight to the bottom line. But when revenue drops, those fixed costs don't drop with it. A professional services firm doing $10M with a heavy salaried team and a long-term office lease has high operating leverage. Win a new client and the margin is strong. Lose two in the same quarter and the bleed is fast. A construction company with mostly subcontracted labor has lower operating leverage. Costs flex with the work. Less upside per project, but more protection on the downside. Neither is better. But you have to know which one you are. When we sit down with a client for a quarterly review, operating leverage is one a topic we usually focus on. It tells us whether they're positioned to scale profitably or whether growth is just going to mean more revenue and more stress. If you don't know your operating leverage ratio off the top of your head, that's the conversation to have with your finance team this quarter.

What is the Impact of Operating Leverage on Valuation Multiples? Many analysts ask why two companies with similar revenues can have completely different valuation multiples. The answer often lies in how operating leverage works beneath the surface. Let us break it down clearly: 1) Operating leverage magnifies both risk and reward Companies with high operating leverage carry more fixed costs. As a result, a small increase in revenue can lead to a sharp rise in operating profits. However, the same structure becomes a burden during revenue declines, leading to disproportionate profit drops. This kind of volatility directly affects how investors assess value. 2) Higher volatility leads to higher perceived risk Investors tend to apply a higher discount rate to companies with more earnings variability. This brings down valuation multiples such as EV/EBIT or EV/EBITDA, especially in industries where the revenue cycle is unpredictable. 3) On the flip side, growth potential is also rewarded In periods of revenue growth, companies with high operating leverage can show faster margin expansion. This scalability often attracts a premium, as the market anticipates stronger earnings momentum over time. 4) The industry context shapes the multiple Capital-intensive sectors like airlines and manufacturing naturally have higher operating leverage, and thus trade at lower multiples due to higher earnings risk. In contrast, asset-light businesses such as SaaS or digital platforms usually exhibit more stable cost structures and are rewarded with higher multiples. 5) Multiples reflect more than current earnings Valuation multiples are not just about today’s profits. They capture investor expectations around risk, growth, and efficiency. If the market believes a company can grow significantly without a matching rise in costs, that belief gets priced into the multiple. Instead of simply comparing numbers across companies, take a moment to ask what the cost structure is telling you. Understanding the nature of operating leverage often reveals why the market places a certain value on a business. Follow for Pratik S Investment Banking Careers and Education. Next batch starts from May 25th