Leverage

debt _ This is gearing or leverage, often expressed as a

shareholder’s equity percentage. It shows how far a company is funded

by loans rather its own capital. A highly

geared or highly leveraged company is one that has a lot of debt compared to equity.

EBIT _ This is interest cover or times interest earned. It

interest charges compares a business’s annual interest payments with

its earnings before interest and tax, and shows how easily the company can pay long-term debt costs. A low interest cover (e.g. below 1.0) shows that a business is having difficulties generating the cash necessary for its interest payments.

BrE: gearing; AmE: leverage

Citigroup Inc Ratios, 2005

	Citigroup	Banking Industry Average	S&P 500 Average
Growth Rates % Sales EPS	11.5 3.2	29.4 21.2	10.7 11.2
Price Ratio P/E Ratio	13.9	14.5	20.6
Profit Margins Pre-Tax Margin Net Profit Margin	21.8 15.5	23.7 16.3	47.3 7.6
Financial Condition Debt/Equity Ratio Interest Cover	1.9 2.0	1.32 2.1	1.1 3.4
Investment Returns % Return On Equity Return On Assets	15.7 1.2	13.2 1.0	14.5 2.5

IV. Answer the following questions

1. Why are profitability ratios used by analysts?

2. What are the kinds of profitability ratios?

3. What does leverage show?

4. What is interest cover?

V. Match the two parts of the sentences. Look at the texts to help you.

1. After borrowing millions to finance the takeover of a rival firm, the company’s

2. Although sales fell 5%, the company’s

3. Like profit growth, return on equity is a measure of

4. With just 24% gearing, the company can afford

1. gross profit margin rose 9% from a year ago, so senior management isn’t worried.

2. how good a company is at making money.

3. interest cover is the lowest it has ever been.

4. to acquire its rival, which would help to increase its steady growth.

VI. Read the text and answer the questions below

Predicting insolvency: the Altman Z-Score

The Z-Score was created by Edward Altman in the 1960s. It combines a set of 5 financial ratios and a weighting system to predict a company’s probability of failure using 8 variables from its financial statements.

The ratios are multiplied by their weights, and the results are added together.

The 5 financial ratios and their weight factors are:

A EBIT / Total Assets x 3.3

B Net Sales / Total Assets x 0.999

C Market Value of Equity / Total Liabilities x 0.6

D Working Capital / Total Assets x 1.2

E Retained Earnings / Total Assets x 1.4

Therefore the Z-Score = A x 3.3+B x 0.999+C x 0.6+D x 1.2+E x 1.4

Interpreting the Z-Score

>3.0 - based on these financial figures, the company is safe

2.7-2.99 - insolvency is possible

1.8-2.7 - there is a good chance of the company going bankrupt within 2 years

< 1.80 - there is a very high probability of the company going bankrupt

Which ratio in the Z-Score takes into account:

1. money used for everyday expenses?

2. undistributed profits belonging to the shareholders?

3. income or earnings before interest and tax are deducted?

4. the current share price?

5. the amount of money received from selling goods or services?