Risk Cluster Framework - How to analyse companies by operating leverage
Type
conference paper
Date Issued
2015-06-27
Author(s)
Abstract
The operating leverage is part of most management accounting textbooks. The considerations are limited to breakeven analysis. However, the operating leverage is a key element of each company's business activities. The volatility of sales and the operating leverage are the main drivers of changes in earnings. This insight stems from the textbook formula of the operating leverage solved for changes in earnings. Because of the importance of earnings for analysts, investors but also executives, the operating leverage is the key information for the assessment of companies. Companies with rigid cost structures are more risky compared to companies with flexible cost structures, because earnings react more sensitive to changes in sales. If operating costs vary with sales, earnings do not change a lot. The developed framework uses changes in sales and the cost structure rigidity to define four risk clusters. Companies within a risk cluster show similar return-risk relations based on accounting figures. The framework is useful for inter-industry analysis. It goes beyond the generally applied approach of defining peer groups according to the industry affiliation. The framework is further used to derive standard strategies based on the considerations of how companies may diversify their product offering to smooth revenues while at the same time use the leverage of the cost structure rigidity to increase profitability. It is a very useful tool to monitor key competitors or for portfolio construction in asset management.
Language
English
Keywords
operating leverage
volatility
breakeven Analysis
cost structure
risk Cluster
earnings
framework
HSG Classification
contribution to scientific community
HSG Profile Area
SoM - Responsible Corporate Competitiveness (RoCC)
Refereed
Yes
Book title
Proceedings of the European Financial Management Association Annual Meeting 2015
Event Title
European Financial Management Association, 2015 Annual Meeting, Conference Proceedings of the European Financial Management Association (1-19)
Event Location
Nyenrode Business Universiteit, Breukelen, The Netherlands
Subject(s)
Division(s)
Eprints ID
242720