Book: Financial Ratios Flashcards
What is leverage
A financial strategy where companies use debt to increase their return on equity
What can you learn from the leverage equation
The relation between return on equity and how the company is financed
Why is debt seen as a good thing by owners
Because creditors often want less from a company then additional owners. One can say that debt is cheaper then equity
Why can debt be seen as a bad thing by owners
Because creditors demand their rate of return regardless of the financial strength of company
Why do owners demand greater returns from highly indebted companies
Because high debt means higher risk
leverage equation
Return(equity) = R(assets) +
(R(a) - interest) * liabilities / equity
Is return on equity stated before tax in the leverage equation
Yea
What is DuPont analysis
To separate ROA or ROCE into more components too see how to improve it
What us the base DuPont equation
ROE = Operating margin * Asset turnover ratio
Asset turnover ratio ATO
Net sales * 2 / total asset(x + x-1)
Operating margin
Operating income + financial revenue / net sales
Operating income
Sales revenue - operating costs
Give the whole DuPont equation
ROE = (operating income and financial revenue / net sales) * (net sales / average total assets)
How do you improve ROA
Increase sales, decrease expenses or rationalize assets
What is asset rationalization
Reducing non current assets while carrying out the same workload or reducing current assets like account receivables or inventory
