Financial Statement Analysis Term Papet
Business and Management
Submitted By kagor
Review of Accounting Studies, 8, 531–560, 2003 # 2003 Kluwer Academic Publishers. Manufactured in The Netherlands.
Financial Statement Analysis of Leverage and How It Informs About Proﬁtability and Price-to-Book Ratios
DORON NISSIM firstname.lastname@example.org Graduate School of Business, Columbia University, 3022 Broadway, Uris Hall 604, New York, NY 10027 STEPHEN H. PENMAN email@example.com Graduate School of Business, Columbia University, 3022 Broadway, Uris Hall 612, New York, NY 10027 Abstract. This paper presents a ﬁnancial statement analysis that distinguishes leverage that arises in ﬁnancing activities from leverage that arises in operations. The analysis yields two leveraging equations, one for borrowing to ﬁnance operations and one for borrowing in the course of operations. These leveraging equations describe how the two types of leverage affect book rates of return on equity. An empirical analysis shows that the ﬁnancial statement analysis explains cross-sectional differences in current and future rates of return as well as price-to-book ratios, which are based on expected rates of return on equity. The paper therefore concludes that balance sheet line items for operating liabilities are priced differently than those dealing with ﬁnancing liabilities. Accordingly, ﬁnancial statement analysis that distinguishes the two types of liabilities informs on future proﬁtability and aids in the evaluation of appropriate price-to-book ratios. Keywords: ﬁnancing leverage, operating liability leverage, rate of return on equity, price-to-book ratio JEL Classiﬁcation: M41, G32
Leverage is traditionally viewed as arising from ﬁnancing activities: Firms borrow to raise cash for operations. This paper shows that, for the purposes of analyzing proﬁtability and valuing ﬁrms, two types of leverage are relevant, one indeed arising from ﬁnancing activities but another from operating...