tailieunhanh - Ebook Financial reporting and analysis (12th edition): Part 2

(BQ) Part 2 book "Financial reporting and analysis" has contents: For the investor, statement of cash flows, expanded analysis; personal financial statements and accounting for governments and not for profit organizations; special industries - banks, utilities, oil and gas, transportation, insurance, and real estate companies,.and other contents. | chapter 9 For the Investor C ertain types of analysis particularly concern investors. While this chapter is not intended as a comprehensive guide to investment analysis, it will introduce certain types of analysis useful to the investor. In addition to the analysis covered in this chapter, an investor would also be interested in the liquidity, debt, and profitability ratios covered in prior chapters. Leverage and Its Effects on Earnings The use of debt, called financial leverage, has a significant impact on earnings. The existence of fixed operating costs, called operating leverage, also affects earnings. The higher the percentage of fixed operating costs, the greater the variation in income as a result of a variation in sales (revenue). This book does not compute a ratio for operating leverage because it cannot be readily computed from published financial statements. This book does compute financial leverage because it is readily computed from published financial statements. The expense of debt financing is interest, a fixed charge dependent on the amount of financial principal and the rate of interest. Interest is a contractual obligation created by the borrowing agreement. In contrast to dividends, interest must be paid regardless of whether the firm is in a highly profitable period. An advantage of interest over dividends is its tax deductibility. Because the interest is subtracted to calculate taxable income, income tax expense is reduced. DEFINITION OF FINANCIAL LEVERAGE AND MAGNIFICATION EFFECTS The use of financing with a fixed charge (such as interest) is termed financial leverage. Financial leverage is successful if the firm earns more on the borrowed funds than it pays to use them. It is not successful if the firm earns less on the borrowed funds than it pays to use them. Using financial leverage results in a fixed financing charge that can materially affect the earnings available to the common shareholders. Exhibit 9-1 illustrates financial .