Risk Measures

Business risk: – related to the company’s income variance

Business risk = coefficent of variation = standard deviation of operating income / mean operating income (use 5-10 yrs data as too short-> not reliable; If too long->not relevant)

sales volatility= SD of sales / mean sales
(use 5-10 yrs data as too short-> not reliable; If too long->not relevant)

Operating leverage =mean [absolute value (% change in operating earning/%change in sales)
(how much the production costs are fixed as opposed to variable. If greater use of fixed costs, greater impact of a change in sales on operating income of a company-> greater the risk will be

Financial risk: - related to the company’s financial structure (use of debt).

Debt to equity = LT debt / Total equity.
(measure of fixed cost financing, the analyst has a choice of whether to include deferred taxes as part of debt; If deferred taxes resulted from accelerated & SL depreciation difference, should not be included; If result from income recognition on LT contracts, taxes will have to paid at some point,->include)

LT debt to total capital = LT debt / LT capital.
(may or may not include deferred taxes)

Total debt ratio = Total interest bearing debt / (Total capital - Non interest bearing liabilities).