Both operating leverage and financial leverage involves some form of magnification. They magnify changes to earnings due to the presence of fixed costs in a firm’s cost structure. However, they differ only in their exact area of influence in the income statement (i.e., where each type of leverage is relevant to). Operating leverage is the magnification on the top half of the income statement- how earnings before interest and taxes (EBIT) respond to changes in sales; the relevant fixed cost is the fixed cost of operating the firm.
Financial leverage involves the magnification on the bottom half of the income statement- how earrings per share (EPS) changes in reaction to changes in EBIT; the relevant fixed cost is the fixed cost of financing (i.e., interest payments).
