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Operating leverage measures the proportion of fixed and variable costs in total costs. This concept is crucial for understanding how changes in sales volume can affect a company's profitability. When a company has high operating leverage, it means it has a greater proportion of fixed costs relative to variable costs. Therefore, as sales increase, a larger portion of that increase contributes to profit because fixed costs remain constant regardless of sales volume.

A company with high operating leverage will experience more significant fluctuations in earnings with changes in sales; a small increase in sales can lead to substantial increases in operating income, while declines in sales can have equally dramatic adverse effects on profitability. Conversely, firms with low operating leverage have a higher proportion of variable costs; they are generally less sensitive to sales fluctuations, leading to more stable earnings.

Understanding operating leverage is essential for management planning and decision-making, particularly in assessing risk and the impact of changes in sales on overall profitability.