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Operating leverage, margin of safety and cost behavior

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Explain how a 3 percent decline in sales at Home Depot could cause a 21 percent decline in profits. What accounting concept was involved, how were the various major types of costs incurred by Home Depot likely affected by the decline in its sales, and the effect of the decline in sales on Home Depot's margin of safety?

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Operating leverage measures a firm's fixed versus variable costs. The greater proportion of fixed costs, the greater the operating leverage. Like financial leverage, operating leverage magnifies results, making gains look better and losses look worse. Both operating and financial leverage increase risks because they make returns less predictable over time. Hence, operating leverage measures ...