Capital productivity expresses the output of a firm using an output to input ratio for a given time period, such as output per machine hour or output expresses as a percentage of the firm's capital employed. The formulae for calculating capital productivity is:

or

Productivity refers to how well things are done in terms of a ratio between the volume of output and the volume of inputs during a given time period. Inputs can refer to labour, capital, or any other factor resource in the production process. An example is the amount of output produced in an hour of work or the output per worker per week.
The formula for calculating the productivity rate is:

For example, suppose a factory produces 2,000 wooden chairs in 8 hours. The productivity rate can then be expressed as the number of chairs produced per hour:

2,000 (chairs) ÷ 8 (hours) = 250 chairs per hour

The importance of operating leverage

Operating profit (also known as operating income) refers to a firm's earnings from sales revenues before interest and taxes are deducted. It is found by subtracting all of a firm's expenses (except interest and taxes) from its total sales earnings.

Operating leverage, also referred to as the Degree of Operating Leverage (DOL), measures how a firm's operating income is affected by its fixed costs, variable costs, and sales volume. The ratio helps managers to determine whether the firms has too many fixed costs (such as rent or mortgage payments) or too many variable costs (cost of sales related to making and/or selling the products). Operating leverage can be used to measure of the impact of an increase in sales revenue on the profit of the business, as this will depend on the firm's fixed and variable costs.

A business with a lot of fixed costs will tend to face more risks. This is because a fall in sales, perhaps caused by an economic recession, will still mean those expenses have to be paid. By contrast, if there is an increase in sales revenues, the firm's fixed costs stay the same, so the business stands to gain a lot more profit.

However, if the business has a lot of variable costs, this is not so much of a risk. This is because if sales revenues fall, so will the firm's cost of sales as variable costs are directly linked to the level of production or output. Hence, operating leverage signifies the importance of controlling fixed costs. Hence, the operating leverage ratio allows a business to see how different types of expenses impact its operating income.

The DOL ratio shows how well a business is using its fixed-cost items (such as rent paid on its premises as well as the machinery and equipment used in the production process) to generate profits. The more profit that a business can squeeze out of its fixed assets (or non-current assets), the higher its degree of operating leverage will be.

Calculating operating leverage

Operating leverage is a ratio, which expresses a firm's fixed costs in relation to its total costs. The formula for calculating a firm's degree of operating leverage (DOL) is:

where:

Q = Quantity (the number of units sold or produced)

P = Price per unit

V = Variable cost per unit

F = Fixed costs (or total fixed costs)

As an example, suppose Xavi Textiles Co. has the following cost and revenue data:

• Sales volume = 50,000 units of output

• Unit price = $10

• Total fixed costs of $80,000, and

• Average variable cost = $4

To calculate Xavi Textiles Co.'s operating leverage, we substitute the figures above in the DOL formula.

• DOL = 50,000 (10 – 4) / (50,000 (10 – 4) – 80,000

• DOL = 300,000 / (300,000 – 80,000)

• DOL = 300,000 / 220,000 = 1.36

What this figure means is that a 10% increase in sales revenue would equal about 13.6% increase in the firm's operating profit (10% × 1.36 = 13.6%).

Using the formula to calculate the degree of leverage, we can see that a firm with lower fixed costs will have a lower DOL. For example, if Xavi Textiles Co.'s fixed costs were halved to $40,000, its degree of leverage would fall to 300,000 / (300,000 – 40,000) = 1.15.

Some investors prefer a low degree of operating leverage (i.e., low fixed costs) because this carries less risk. However, other investors prefer a higher DOL (i.e., more fixed cost items) because operating on a larger basis can lead to more profits, even though this carries more risks.

If a firm has a low degree of operating leverage due to the majority of its production costs being variable costs, this could suggest the firm would benefit from automation. This would help to reduce the firm's variable costs of production, although the fixed costs (for the automation, including the costs of machinery and capital equipment) would be high. Nevertheless, as less of the costs are directly related to production levels, any increases in demand for the firm's output will not raise total costs by as much. Therefore, the business can earn more profit.‍

A higher degree of operating leverage ratio tends to be better for businesses. If a firm's operating leverage is less than 1.0, this means it costs the business more to produce something than it earns in profits. This suggests that the business needs to reassess its pricing methods and/or streamline its operations in order to reduce its costs.