How Reverse Pitching Works? – Its Advantages & Disadvantages
Start-ups connect with large corporations in many ways. The most common way for start-ups to connect with their larger counterparts is when they try to raise funds from these companies. It is common for start-up companies to approach bigger firms in order to pitch their business. However, a lot has changed in the start-up community […]
Disadvantages of Securitization in Sports
In the previous articles, we have already seen how the use of securitization has grown in sports. We also know that the increasing use of securitization is because of certain benefits that are provided by this method of raising capital. However, it is important to note that securitization is a part of structured finance. Structured […]
Private Equity Investments in the Sports World
Sporting franchises across the world have traditionally been owned by wealthy individuals. This has largely been because of the fact that sporting franchises have been viewed less as financially viable investments and more as vanity toys. However, all this has started changing in the wake of stellar returns provided by sporting franchises in the recent […]
Accounts Receivable Turnover Ratio
Accounts receivable are a very important part of the current assets of any business. Like inventory, accounts receivable are considered a necessary evil to do business. Large companies hardly conduct any transactions on cash basis with their wholesalers and distributors. The transactions are largely conducted on credit and therefore lead to the existence of accounts […]
Advantages and Limitations of a Budget
In the previous article, we learned about the three financial statements. We also learned how income statements and balance sheets are backward-looking financial statements. We also understood that the budget is the only forward-looking financial statement in the personal finance domain. It is the only statement that can be used to prevent economic mistakes from […]
A high debt equity ratio makes the company financed by debt more than by equity. Therefore there are fixed interest payments involved. Hence when the going is good, the company makes a handsome return as a small percentage of change in EBIT creates a large percentage change in earnings per share. However the inverse of this is also true. Just like financial leverage helps to magnify profits, it also magnifies losses when EBIT fall down. Analysts want to quantify exactly how much variability does debt funding create in the operations of a particular company and have created a measure called “Degree of Financial Leverage” which we will study in detail.
Degree of Financial Leverage = % Change in EPS / % Change in EPS
There is a reasonable assumption about the absence of any changes in accounting policy which would make the EPS and EBIT figures incomparable from the previous years.
Thus, you are obligated to pay Rs 7 interest each year, regardless of what happens. Lets say that the price of the house went up by 20% to 120. In this case you will pay back the creditors Rs 77 (principal + interest) and be left with Rs 43. Since your original investment was Rs 30, you have gained Rs 13.
A price increase of 20% has led to an increase in the shareholders return by approximately 43%!
Thus, you are obligated to pay Rs 7 interest each year, regardless of what happens. Lets say that the price of the house went down by 20% to Rs 80. In this case you will pay back the creditors Rs 77 (principal + interest) and be left with Rs 3. Since your original investment was Rs 30, you have lost Rs 27.
A price decrease of 20% has led to a decrease in the shareholders return by approximately 90%
Leverage is very dangerous unless the company is reasonably certain of its earnings. Investors view the leverage ratio with great detail. This is because it enables a small change in the EBIT to completely wipe out the company’s capital and make it insolvent almost overnight.
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