Sloan Man. Fin. Exam 2 Ratio Interpretations

What is a synonym for leverage and what good and bad can leverage do for a company?

Synonyms for leverage include debt and borrowing. Leverage amplifies positive returns and losses.

Why is the gross profit margin important?

The GPM is important because it determines how many $'s are available to cover the rest of a company's expenses.

What is the definition of liquidity?

The ability to convert an asset into cash quickly and at a fair price. The ability of a company to pay its expenses and obligations as they come due.

What is the downside of having a relatively high leverage ratio?

The downside of a higher leverage ratio is the potential for financial distress in the event sales and/or gross profit are declining. Leverage involves fixed costs that can be problematic in a weak environment.

How many components are there in a ratio and how many possible explanations are there behind changes in a ratio?

The numerator changes, but the denominator does not. The denominator changes but the numerator does not. They both change, but at different rates.

What are two explanations for a high A/R turnover ratio?

The staff is effective at collecting receivables. You have a receivables policy that is conservative. Check to see if it is too conservative.

What is the upside of having a relatively high leverage ratio?

The upsides to having a relatively high leverage ratio are the extra profits you can make and the lower equity investment that is needed. This results in a higher ROE.

How does a company achieve a degree of financial leverage?

This occurs when a company borrows money to buy back stock, which reduces the # shares outstanding.

What does a firm do to achieve operating leverage?

Use automation and technology to lower the cost of producing goods and services.

What are two explanations for a low A/R turnover ratio?

You have a receivables policy that is liberal. Check to see if it is too liberal.

What are the two ways to assess the ability of a company to meet its obligations?

compare current assets to current liabilities add cash flow like ebit, ebitda or nopat to current assets & compare to current liabilities & other obligations

What 3 things affect gross profit margin %?

pricing sourcing input (COGS) product mix

4 things you need to know about ratios are:

what are they trying to measure, what is the formula, where do you get the data for the formula and how do you interpret the output.

What is the formula for the Quick or Acid-Test ratio?

(CA - Inv) / current liabilities

What 2 things affect net profit margin?

Interest expense and taxes

How do you calculate the $ amount of interest expense?

Interest rate x principal owed

Is it better to have high/rising margins or low/declining margins?

High or rising margins are much better. They imply rising cash flow and improving financial strength.

What does it mean for a company to have a degree of financial leverage?

A degree of financial leverage is achieved when a small change in ebit leads to a larger change in EPS

What are 4 things you need to know about ratios?

1- What aspect of a business are the ratios measuring? 2- What are the formulas for the ratios? 3- Where do you get the data to plug into the formulas? 4- How do you interpret the ratios?

Why do companies buy assets and what 2 fixed costs are affected by leverage? What is a fixed cost?

Companies buy assets in order to generate cash flow. Two fixed costs related to leverage are interest and depreciation expenses. A fixed cost is an expense that is not related to nor does it vary with sales.

What are the two components of a company's capital structure?

Debt and equity

What is depreciation related to?

P,P & E

What are peer and trend analysis and why is it important to do it?

Peer analysis involves computing ratios for a group of companies and comparing those ratios. Trend analysis involves computing ratios for a companies for several periods. The purpose of trend and peer analysis is to create context. We are trying to turn data into insight.

What 2 things affect operating margin?

S,G & A expenses and depreciation