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Capital structure - Income statement

Q: Why is the gross profit figure of a business more important than revenues?

Because it measures the amount of in-house value-add , while the revenue figure just measures the business' turnover, irrespective if a business has produced something valuable or invaluable .

Q: What does a high gross margin mean?

A high in-house value-add and a high increase in profitability when sales grow.

Q: What is operating leverage?

The extent to which profit growth outgrows sales growth .

Q: What does the EBITDA figure allow in terms of comparison?

It allows to compare businesses with different balance sheet structures , asset bases , or tax regimes .

10 important questions on Capital structure - Income statement

Why is the gross profit figure of a business more important than revenues?

Because it measures the amount of in-house value-add, while the revenue figure just measures the business' turnover, irrespective if a business has produced something valuable or invaluable.

What does a high gross margin mean?

A high in-house value-add and a high increase in profitability when sales grow.

What is operating leverage?

The extent to which profit growth outgrows sales growth.

What does fixed costs consist of?

Marketing, selling, administrative and back-office costs, rent and utility costs, depreciation, etc.

How can the EBIT figure be influenced strongly by depreciation?

Depreciation can be very different from what a business actually spends on its equipment.

What does EBITDA better understand than EBIT?

The underlying profitability of a business, as amortisation and impairments can deceive EBIT substantially.

What does the EBITDA figure allow in terms of comparison?

It allows to compare businesses with different balance sheet structures, asset bases, or tax regimes.

If a company is operating with an old and largely depreciated asset base, and assuming everything else equal, its EBIT margin may be higher than the EBIT margin of a company with a state-of-the-art asset base.

The latter is more valuable. Why is that?

Because the asset base will last longer than the one of the first-mentioned company, but its profit margin (EBIT margin) could still be lower.

Why is the EBIT figure for mature and stable companies a near-cash figure after the required cash-out to maintain the asset base?

Because mature and stable companies typically have a depreciation rate in the order of magnitude as its capital expenditure, i.e. The cash needed to maintain and occasionally renew its asset base.

Consider an asset with an original cost of $100,000, an expected life of five years, and an estimated salvage value of $20,000. Under straight-line depreciation, the net book value of the asset after two years would be?

$100,000 - 20,000 = $80,000

$80,000 / 5 = $16,000

$100,000 - 16,000 - 16,000 = $68,000

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A practical guide to interpreting financial statements and valuing companies

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Capital structure - Income statement

10 important questions on Capital structure - Income statement

Why is the gross profit figure of a business more important than revenues?

What does a high gross margin mean?

What is operating leverage?

What does fixed costs consist of?

How can the EBIT figure be influenced strongly by depreciation?

What does EBITDA better understand than EBIT?

What does the EBITDA figure allow in terms of comparison?

If a company is operating with an old and largely depreciated asset base, and assuming everything else equal, its EBIT margin may be higher than the EBIT margin of a company with a state-of-the-art asset base. The latter is more valuable. Why is that?

Why is the EBIT figure for mature and stable companies a near-cash figure after the required cash-out to maintain the asset base?

Consider an asset with an original cost of $100,000, an expected life of five years, and an estimated salvage value of $20,000. Under straight-line depreciation, the net book value of the asset after two years would be?

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If a company is operating with an old and largely depreciated asset base, and assuming everything else equal, its EBIT margin may be higher than the EBIT margin of a company with a state-of-the-art asset base.

The latter is more valuable. Why is that?