Ratios & Financial Management Flashcards
Operating Leverage
How sensitive a company’s operating income is to changes in sales
Degree of Operating Leverage
% change in Operating Income (EBIT)/ % change in Sales
Having high operating leverage is (increase/decrease) risk, (increase/decrease) reward and indicates more (variable/fixed costs)
increased risk, increased reward, fixed costs
Having a lower operating leverage indicates more (variable/fixed costsO
variable costs
The higher the DOL is, the (greater/less) operating income is sensitive to changes in sales
greater
Financial leverage
How sensitive a company’s EPS is to fluctuations in operating income as a result of capital structure
What are fixed financial leverage costs?
Interest on bond debt
What are variable financial leverage costs?
dividends
What are fixed operating leverage costs?
Rent/utilities
What are variable operating leverage costs?
Sales commissions
Return on Investment
Net income (net of tax)/ Invested Capital* or Total Investment
*(debt + equity)
How can we utilize profit margin to calculate return on investment?
Profit Margin x Investment Turnover
T/F higher % is better and indicates more profit?
F - higher % is better, but doesn’t indicate profit
Profit Margin
Net Income/ Sales
Investment Turnover
Sales/ Average total investment
Return on Equity
Net Income/ Total Stockholder’s Equity
Dupont Formula
Net Profit Margin x Asset Turnover X Financial Leverage
What does Net Profit Margin tell us?
For every dollar of sales, how much profit is being produced
What does Asset Turnover tell us?
Degree of efficiency company is in using its assets
What does Financial Leverage tell us?
Extent to which a company uses debt in its capital structure
Return on Assets
Net Income/ Total Assets
Residual Income
Measures excess of income earned above and beyond required return expressed in dollars
RI Formula
(Invested Capital x % rate of return) - Operating income from investment
Economic Value Added
Measures net operating profit (NOPAT) after taxes to weighted average cost of capital
EVA Formula
NOPAT: EBIT x (1-tax rate)
NOPAT - Required Return in dollars*
*Total assets x WACC %
APR of Quick Payment Discount
Discount %/(1-discount %) X Total Days in Year/Days paid early
What are the steps of factoring receivables?
- Calculate Interest costs
A. Monthly receivables advanced % X Average Receivables
B. Interest on monthly advance
C. Multiply by 12 for annual interest - Calculate Factoring Fee
A. Monthly factoring fee
B. Multiply by 12 for annual factoring fee - Calculate total Annual Cost
Annual interest + Annual Factoring - Annual Savings - Calculate % of Factoring
Annual Cost/Average Monthly Advances
Float
Difference between the balance of checks outstanding (which haven’t cleared the bank) and deposits made that haven’t cleared the bank
Objective of utilizing float
Minimize collection float and maximize disbursement float
Inventory Turnover
COGS/Average Inventory
Inventory Conversion
365 X EI/COGS
AR Turnover
Net Credit Sales/ Average AR
