Archive for category profit margin
The ratio of sales to loans and assets
Posted by admin in Business plans, Companies, Money Tips, Taxes, communication, market demand, market forecasts, profit margin, understanding finances on October 28th, 2009
The ratio of sales to assets is an asset turnover ratio that measures the sales-generating capacity of a given asset base. Taking the nominal GDP of the nonfinancial corporate sector as a measure for sales. The ratio has started to turn up at the beginning of 2001. This pattern is normally consistent with periods of recovery. However, it should be noted that this ratio is near its historical low. The z-score for the nonfinancial corporate sector has collapsed dramatically since 2000, resting well below the critical level of 1.8 since the second quarter of 2002. For an individual firm this signals that the company is likely to fail within 2 years. On the macro level it indicates a high probability of rising default rates and widening credit spreads. Three points stand out:
- based on macroeconomic data the z-score has never been in the safe zone;
- the average score since 1952 is about 2;
- in the 1970s and 1980s, the z-score was permanently in the distress zone implying that corporate America should have gone bankrupt, but clearly it survived.
This leads to the conclusion that the weighting scheme is no longer appropriate to capture the vulnerability of the corporate sector. The relative importance of the individual factors changes over time. Therefore, it is necessary to adjust the weighting scheme on a regular basis, for example by using a regression methodology.
The ratio of credit earnings before tax, interest depreciation
Posted by admin in Companies, Investment Opportunities, budget, fixed costs, management skills, manufacturing, market demand, production cycles, profit margin on October 27th, 2009
A second metric for profitability is the ratio of earnings before tax, interest depreciation and amortization (EBITDA) to total assets. Using data from the national accounts of the United States we define earnings before tax and interest as pre-tax profits with inventory valuation and capital consumption adjustment plus net interest. This metric follows a similar path as the ratio of retained earnings to total assets, although on a higher level and with a higher volatility.
Measuring the extent to which a firm’s value can decline before its book value becomes negative and a firm becomes insolvent, the ratio of market value of equity to total debt represents the inverse of leverage. We have defined the value of equity as the market value of outstanding equities, total debt is defined as total credit market instruments. The tremendous equity bubble of the late 1990s has collapsed, but nevertheless the equity-to-debt ratio stays above the level reached in the 1970s and 1980s. Because of its higher volatility, the ratio is largely driven by the equity performance. As a result the equity-to-debt ratio usually rises at the end of a recession because equity markets already
anticipate stronger economic growth while many companies still deleverage their balance sheets. Here again, the 2001 recession makes an exception.
About one-and-a-half years after the end of the recession in November 2001 equity markets finally marked their lows.
The fundamentals of credit valuation
Posted by admin in Save Money, performance objectives, profit margin, profit projections, revenue, understanding finances, variable costs on October 24th, 2009
Besides market fundamentals valuation is the major driver of market performance for the longer term. The other two drivers that are commonly mentioned in investment literature, technicals and market sentiment, are more likely to explain short- to medium-term fluctuations of credit spreads.
The subject of valuation arises on every level of the investment process. Generally, it is a question of relative attractiveness of one investment vis-avis another one. In this chapter, we will outline four approaches that may support asset allocation decisions in fixed income portfolios with an aggregate benchmark as well as help to determine the beta of a pure credit portfolio.
Innumerable financial and accounting schemes
Posted by admin in consulting, fixed costs, market forecasts, profit margin on October 5th, 2009
Innumerable financial and accounting schemes, all legal, also dilute your share of profits. Accounting tricks include non-deducted stock options, accruing unearned sales and commissions, classifying big losses as nondeducted special items, and counting pension gains as income. All tricks make earnings appear higher than they really are. Creating huge reserves in a bad year is common as well. This allows the company to then post high earnings in succeeding years. Many companies also use cash flow to speculate in the stock of hot companies. This boosts profits quickly, though it turns a solid business into a volatile investment fund. Companies also finance purchases by shaky customers. This boosts sales and profits in the shortterm but leads to huge write-offs later when the shaky customers fail.
All these accounting tricks inflate profits short-term. Higher profits justify higher salaries, bonuses, and grants of stock options. When these tricks are discovered and set right, earnings are restated and your stock price collapses. However, bonuses and salaries are long gone and stock options cashed. A series of legal accounting schemes can siphon off all earnings and leave the company bankrupt and you holding a worthless stock certificate.
Enron is a recent example. Enron used off balance sheet entities to inflate profits and enrich management. When the tricks were discovered, the stock price collapsed; outside shareholders ended up with penny stocks.
Understanding Debits and Credits – part 2
Posted by admin in Investment Opportunities, market demand, ownership, paperwork, profit margin, short-term income on August 3rd, 2009
Company financial operations also generate two other accounting statements:
Income statement—a summary of business revenue and expenses for a specific period of time.
Statement of owners’ equity—a record of the value or percentage of ownership held by individuals or firms with a stake in the business.
The primary purpose of all such statements is to help keep the company finances in balance. To that end, all debits must equal credits and all credits must equal debits when reflected on the balance sheet and income statement. If they don’t, the balance sheet won’t balance.
Your accountants may also generate another statement, for cash flow. We’ll discuss cash flow later; for now, all you need to know is that while the income statement and the statement of owners’ equity show the state of finances, the cash flow statement tells how the company reached that state. In essence, it accounts for how cash came in and how it went out.
Drafting a Budget
Posted by admin in Real estate, production cycles, profit margin, profit projections, short-term income on August 2nd, 2009
So what does a budget look like? There are numerous variations, but the goal of any budget is to clearly communicate revenue and cost centers so that profit statements can be drafted and management of resources, including income, can be better accomplished. To that degree, all budgets tend to look the same.
For the sake of this lesson, let’s assume our unit maker described earlier has been in business several years and is charged with budgeting for next year. That means he will have budgets from previous years from which to draft future business plans. The operational budget, then, likely will break revenue and expense components down to three columns:
1. The current year’s budget, or what he originally projected his income and expenses to be.
2. The current year’s projected year-end actual expenses and revenues. Even if it’s a guess, which it tends to be, it must be as accurate a guess as possible.
3. The next year’s budget, which tends to be a hybrid between the actual budget, the year-end projected actuals, and a best guess for what the new year will bring.
Fixed and Variable Costs in fiction – part 2
Posted by admin in Companies, effective budgeting, equity, material costs, profit margin on August 1st, 2009
But now let’s say each one of these units requires $3 worth of raw materials and another $2 in assembly charges to create, or $5 per unit. Since those costs are based on the number of units being produced, those costs are variable with the production flow. If you produce 5,000 units, that’s a variable cost of $25,000. Add to that your $10,000 per year in fixed costs, and you have overall production costs of $35,000, or $7 per unit. At a sales price of $9, the profit margin is $2 per unit.
But let’s increase production to 10,000 at $5 per unit in materials and assembly charges. That’s $50,000 in variable costs, plus $10,000 in fixed costs, for a total of $60,000 for 10,000 units. The price per unit is now $6, which yields a profit margin of $3 per unit.