Final answer:
The magnitude of operating leverage is determined by the formula Contribution margin ÷ Net income. This ratio helps businesses understand the relationship between sales and net income, indicating the potential for profit changes with sales fluctuations.
Step-by-step explanation:
The magnitude of operating leverage can be determined using the formula for calculating the degree of operating leverage (DOL), which is the ratio of contribution margin to net income. Therefore, the correct formula from the given options is Contribution margin ÷ Net income. Understanding the operating leverage is important for a firm, as it shows how responsive the net income is to a change in sales. High operating leverage indicates that a small change in sales can lead to a significant change in net income.
The contribution margin represents the amount remaining from sales revenue after all variable costs have been deducted, which then contributes to covering fixed costs and generating profit. The net income, also known as accounting profit, is the total revenues minus both explicit costs, including depreciation, and other costs. By comparing the contribution margin to the net income, businesses can gauge their operational efficiency and the impact of fixed costs on profitability.