Certified Management Accountant Practice Exam 2025 – The Comprehensive All-in-One Guide to Exam Success!

A higher Degree of Operating Leverage (DOL) indicates that a company has a higher proportion of fixed costs in its cost structure. This concept is key in understanding how a company's operating income can be affected by changes in sales volume.

When a company has a significant amount of fixed costs, the first portion of any sales increase affects operating income more dramatically because those fixed costs do not change with the level of production. As sales increase, the fixed costs remain constant while the contribution margin from each additional unit sold contributes directly to profit. Conversely, if sales decline, the impact on profit can be substantial due to the fixed costs remaining on the books irrespective of sales performance.

In contrast, a lower proportion of variable costs would mean the company has more fixed commitments that do not fluctuate with production levels. In this context, equal proportions of fixed and variable costs would not indicate a higher DOL, and a focus on reducing overall costs doesn't specifically relate to operating leverage but rather to cost management strategies. Thus, understanding that a higher DOL reflects a structural reliance on fixed costs is critical for analyzing business risk and leveraging for profitability.