49 Questions
What is the main underpinning of a company's operating leverage?
Fixed operating expenses
What does a higher level of operating leverage typically indicate?
Higher business risk
Why do companies with high operating leverage have substantial upside profit potential after covering their fixed expenses?
Minimal variable expenses
How does a rapid reduction in revenues impact a company with high operating leverage?
Limits the ability to respond
Why are extraordinary expenses reported separately from regular expenses on the income statement?
To indicate their unusual nature and infrequent occurrence
Why does S&P include employee stock option grant expense in core earnings?
Because S&P believes that all parts of employee compensation should be included.
Why does S&P exclude unrealized gains/losses from hedging activities from core earnings?
Because they are not considered part of ongoing operations.
Why does S&P exclude goodwill impairment charges from core earnings?
Because they represent a reduction in the value of assets.
What is S&P's rationale for including restructuring charges from ongoing operations in core earnings?
Because they relate to costs and expenses of activities involved in creating products or services.
Why does S&P exclude pension gains from core earnings?
Because pension gains do not impact a company's operating revenues.
What does the quality of earnings refer to in the context of financial analysis?
The consistency and reliability of a company's net income
Which factor is NOT considered when assessing the dependability of net income in financial analysis?
Market capitalization of the company
In income statement analysis, what does identifying the base earnings profile involve?
Excluding nonrecurring revenues and expenses to determine the ongoing earnings capability
How does conservatism in accounting practices affect a company's balance sheet and reported earnings?
It leads to more conservative balance sheets and reliable reported earnings
Why is it important to evaluate the comparability of expenses in financial analysis?
To prevent misleading trend analysis and comparisons
What is the primary purpose of separating mixed costs into their fixed and variable components?
To facilitate accurate break-even analysis and measure operating leverage
Which of the following is NOT a common method used to separate mixed costs into fixed and variable components?
Detailed budgeting and forecasting
Why are lenders generally unable to accurately distinguish between a company's fixed and variable expenses based solely on the financial statements?
The separation of fixed and variable costs requires complex statistical techniques
Which of the following is an example of a mixed cost provided in the passage?
Telephone expense for a telemarketer
What does the net profit margin measure?
The overall profitability of a company after all income and expense items have been accounted for
Why is the pretax profit margin sometimes considered more valid than the net profit margin?
Because it eliminates the effect of tax strategies and extraordinary income or expense
What is the significance of the operating profit margin?
Studying the reasons for change in the operating profit margins helps you isolate causes of, and changes in, profitability
What is the significance of the gross profit margin?
The gross profit margin is an important measure of profitability because cost of sales often represents the largest portion of expenses, and it must be sufficient to cover operating expenses and expected profits
What are some key questions to consider when interpreting trends in a customer's gross profit margin?
Both a and b
Which of the following does S&P believe should be included in core earnings?
Merger/acquisition related expenses
Which of the following does S&P believe should be excluded from core earnings?
All of the above
Why does S&P believe that goodwill impairment charges should not be included in core earnings?
Because a goodwill impairment implies that the company's earnings will suffer in the future, including the charge would doubly penalize the company's performance.
Why does S&P exclude gains/losses from asset sales from core earnings?
Because companies are not in the business of buying and selling their operating assets, with exceptions noted for firms such as real estate companies that do indeed trade in assets as normal activity.
Which of the following does S&P believe should be excluded from core earnings?
Pension gains
If a company's contribution margin percentage decreases, which of the following is true regarding its break-even point?
The break-even point increases, requiring higher sales revenue to cover fixed expenses
Which of the following ratios indicates the number of times a company's operating earnings cover its interest expense?
Interest coverage ratio
If a company's fixed charge coverage ratio is less than 1, what does it imply?
The company's profitability is not sufficient to cover its interest, lease, rental expenses, and current portion of long-term debt.
If a company's operating leverage percentage increases, what can be inferred about its cost structure?
The company has increased its fixed operating expenses relative to its total operating expenses
If a company's pricing strategy results in a significant increase in the cost of goods sold, which of the following is a potential consequence?
The company's gross margin may decrease, leading to lower profitability
If a company's dividend payout ratio exceeds 1.0x, what does it suggest?
The company is paying out more in dividends to its shareholders than it is earning.
If a company's management demonstrates the ability to strategically respond to market shifts that permanently alter the potential for gross profit, what can be inferred about the company's creditworthiness?
The company's creditworthiness is likely to improve due to its strategic agility
Which of the following steps should be taken when interpreting asset turnover ratios?
All of the above.
If a company experiences a rapid reduction in revenues while maintaining a high operating leverage percentage, what is the likely impact on its profitability?
Profitability will likely decrease significantly due to the high fixed cost burden
What is the primary limitation of using turnover ratios to evaluate a company's financial efficiency?
All of the above are limitations of using turnover ratios to evaluate financial efficiency.
What is the formula for the Debt to Worth ratio in financial analysis?
(Liabilities / Net Worth)
In financial analysis, what does the term 'Unfunded PBO' represent?
Projected Benefit Obligations minus Fair Value of Plan Assets
How is the Operating Profit Leverage (OP Leverage) calculated in financial analysis?
Total Fixed Costs divided by Total Operating Costs
What is the purpose of the 'Minimum Liability' concept in financial reporting?
To measure the leverage impact of pension obligations
How can a 1% increase in the discount rate affect the Projected Benefit Obligations (PBO) according to the text?
Swings PBO between 8-15%
What does the current ratio measure?
The ability to cover current liabilities with current assets
What is the purpose of the quick ratio?
To measure the coverage of current liabilities by liquid assets, excluding inventory
What does the inventory reliance percentage indicate?
The extent to which a company relies on inventory to cover current liabilities
What is the significance of net working capital?
It represents the dollar amount by which current assets exceed current liabilities
What is the purpose of capitalizing leases according to S&P?
To account for the future minimum lease commitments as debt and long-term assets
Learn about mixed costs, also known as semi-fixed costs, which consist of both a fixed and variable element. Explore examples like telephone expenses for telemarketers and management compensation. Understand how these costs are calculated and managed.
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