Corporate Governance and Financial Management

Financial management

Corporate governance
Part A: Risk and Return for Portfolios
2016 2017
Company A Company B
Company
A
Company
B
Sales ($
million) 10.7 13.9 11.6 14.6
EBIT ($ million) 5.7 7.4 6.2 8.1
Assets ($
million) 10.7 15.6 10.7 15.6
Debt ($ million) 5.8 9.3 5.8 9.3
Interest ($
million) 0.6 1 0.6 1
Equity ($
million) 4.9 6.3 4.9 6.3
PBT 5.1 6.4 5.6 7.1
Return on
Equity 1.04 1.02 1.14 1.13
Company A Company B
Change in EBIT 0.5 0.7
% change in EBIT 8.8% 9.5%
Change in Sales 0.9 0.7
% Change in
Sales 8.4% 5.0%
Operating
leverage 1.04 1.88
Return on assets 10% 20%
Net Operating
Assets 62 40.5
Financial Leverage 0.09 0.23
1. Operating leverage= %Change in EBIT/% change in sales
2. Return on equity= Net income/Equity
3. Assuming interest, debt and assets remain same in 2017
4. Return on assets= EBIT/Net Operating Assets
5. Financial Leverage= total debt/total assets
A high operating leverage shows the profit generating capacity of a company for a delta
change in sales. A higher operating leverage ratio is a positive sign. Hence, the operating
leverage of Company B is favorable.
2

Corporate governance
However, a higher financial leverage ratio indicates an increased interest bearing of the
company which negatively affects the earnings per share of the company. Company A enjoys
a favorable financial leverage.
3