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The degree of operating leverage is a key concept in financial management that reflects how sensitive a firm's operating income is to changes in sales volume. When a company has high operating leverage, it means that a significant proportion of its costs are fixed rather than variable. This structure can lead to higher profits when sales increase, but it also means that losses can increase more dramatically if sales decline.

Therefore, higher leverage equates to higher risk because the firm becomes more sensitive to sales fluctuations. A small change in sales can lead to a disproportionate impact on operating income, indicating a higher volatility in earnings. This heightened sensitivity amplifies the financial risks associated with downturns in sales or unexpected costs.

In contrast, firms with lower operating leverage typically have a higher proportion of variable costs, which allows them to respond more flexibly to changes in sales volumes. As such, they encounter less risk related to fixed costs when market conditions are unfavorable. Understanding this relationship helps analysts and managers evaluate the potential risks and rewards associated with a firm’s operational structure.