Gross Profit Margin Ratio Analysis

The gross profit margin ratio analysis is an indicator of a company’s financial health. It tells investors
how much gross profit every dollar of revenue a company is earning. Compared with industry
average, a lower margin could indicate a company is under-pricing. A higher gross profit margin
indicates that a company can make a reasonable profit on sales, as long as it keeps overhead costs in
control. Investors tend to pay more for a company with higher gross profit.

If there are sales returns and allowances, and sales discounts, make sure that they are removed from
sales so as not to inflate the gross profit margin. A more accurate formula is:

Gross profit ÷ Net sales

where: Net sales =

Gross sales – Sales Returns and Allowances – Sales Discounts

Interpreting the Gross Profit Margin

Generally, the higher the gross profit margin the better. A high gross profit margin means that the
company did well in managing its cost of sales. It also shows that the company has more to cover for
operating, financing, and other costs. The gross profit margin may be improved by increasing sales
price or decreasing cost of sales. However, such measures may have negative effects such as
decrease in sales volume due to increased prices, or lower product quality as a result of cutting
costs. Nonetheless, the gross profit margin should be relatively stable except when there is
significant change to the company’s business model.

Understanding the Ratio

The net profit margin ratio is used to describe a company’s ability to produce profit and to consider
several scenarios, such as an increase in expenses which is deemed ineffective. It is used extensively
in financial modeling and company valuation.

Net profit margin is a strong indicator of a firm’s overall success and is usually stated as a
percentage. However, keep in mind that a single number in a company report is rarely adequate to
point out overall company performance. An increase in revenue might translate to a loss if followed
by an increase in expense. On the other hand, a decrease in revenue, followed by tight control over
expenses, might put the company further in profit.

Other common financial metrics are EBITDA and Gross Profit.

A high net profit margin means that a company is able to effectively control its costs and/or provide
goods or services at a price significantly higher than its costs. Therefore, a high ratio can result from:

 Efficient management

 Low costs (expenses)

 Strong pricing strategies

A low net profit margin means that a company uses an ineffective cost structure and/or poor pricing
strategies. Therefore, a low ratio can result from:

 Inefficient management

 High costs (expenses)

 Weak pricing strategies

Investors need to take numbers from the profit margin ratio as an overall image of
company profitability performance and initiate deeper research on the cause of an increase or
decrease in the profitability as needed.

Analysis

The operating profit margin ratio is a key indicator for investors and creditors to see how businesses
are supporting their operations. If companies can make enough money from their operations to
support the business, the company is usually considered more stable. On the other hand, if a
company requires both operating and non-operating income to cover the operation expenses, it
shows that the business’ operating activities are not sustainable.

A higher operating margin is more favorable compared with a lower ratio because this shows that
the company is making enough money from its ongoing operations to pay for its variable costs as
well as its fixed costs.

For instance, a company with an operating margin ratio of 20 percent means that for every dollar of
income, only 20 cents remains after the operating expenses have been paid. This also means that
only 20 cents is left over to cover the non-operating expenses.

Analysis and Interpretation

The degree of operating leverage can show you the impact of operating leverage on the
firm’s earnings before interest and taxes (EBIT). Also, the DOL is important if you want to assess the
effect of fixed costs and variable costs of the core operations of your business.

A high degree of operating leverage provides an indication that the company has a high proportion
of fixed operating costs compared to its variable operating costs. This means that it uses more fixed
assets to support its core business. It also means that the company can make more money from
each additional sale while keeping its fixed costs intact. So, the company has a high DOL by making
fewer sales with high margins. As a result, fixed assets, such as property, plant, and equipment,
acquire a higher value without incurring higher costs. At the end of the day, the firm’s profit margin
can expand with earnings increasing at a faster rate than sales revenues.

On the other hand, a low DOL suggests that the company has a low proportion of fixed operating
costs compared to its variable operating costs. This means that it uses less fixed assets to support its
core business while sustaining a lower gross margin.

It is important to understand that controlling fixed costs can lead to a higher DOL because they are
independent of sales volume. The percentage change in profits as a result of changes in the sales
volume is higher than the percentage change in sales. This means that a change of 2% is sales can
generate a change greater of 2% in operating profits.

Asset turnover Analysis

This ratio measures how efficiently a firm uses its assets to generate sales, so a higher ratio is always
more favorable. Higher turnover ratios mean the company is using its assets more efficiently. Lower
ratios mean that the company isn’t using its assets efficiently and most likely have management or
production problems.

For instance, a ratio of 1 means that the net sales of a company equals the average total assets for
the year. In other words, the company is generating 1 dollar of sales for every dollar invested in
assets.

Like with most ratios, the asset turnover ratio is based on industry standards. Some industries use
assets more efficiently than others. To get a true sense of how well a company’s assets are being
used, it must be compared to other companies in its industry.

The total asset turnover ratio is a general efficiency ratio that measures how efficiently a company
uses all of its assets. This gives investors and creditors an idea of how a company is managed and
uses its assets to produce products and sales.

Sometimes investors also want to see how companies use more specific assets like fixed assets and
current assets. The fixed asset turnover ratio and the working capital ratio are turnover ratios similar
to the asset turnover ratio that are often used to calculate the efficiency of these asset classes.

Analysis

Inventory turnover is a measure of how efficiently a company can control its merchandise, so it is
important to have a high turn. This shows the company does not overspend by buying too much
inventory and wastes resources by storing non-salable inventory. It also shows that the company can
effectively sell the inventory it buys.

This measurement also shows investors how liquid a company’s inventory is. Think about it.
Inventory is one of the biggest assets a retailer reports on its balance sheet. If this inventory can’t be
sold, it is worthless to the company. This measurement shows how easily a company can turn its
inventory into cash.

Creditors are particularly interested in this because inventory is often put up as collateral for loans.
Banks want to know that this inventory will be easy to sell.

Inventory turns vary with industry. For instance, the apparel industry will have higher turns than the
exotic car industry.

A low inventory turnover ratio shows that a company may be overstocking or deficiencies in
the product line or marketing effort. It is a sign of ineffective inventory management because
inventory usually has a zero rate of return and high storage cost. Higher inventory turnover ratios
are considered a positive indicator of effective inventory management. However, a
higher inventory turnover ratio does not always mean better performance. It sometimes may
indicate inadequate inventory level, which may result in decrease in sales.
Advantage: Management Comparison

Age of inventory analysis is an easy way of comparing the management and efficiency of two
companies. Using the above example, the first company had an average age of inventory of 121.67
days while the second company had an average age of inventory of only 36.5 days. You could then
infer that the second company is better at selling its goods and clearing its inventory at a faster rate.
Even if the comparison involves two identical stores in two completely different locations, for
example, on in an urban area and the other in a rural area, the measurement still works as each
store will start off with different levels of inventory.

Average Age Of Inventory

A high average age of inventory can indicate that a firm is not properly managing its inventory or
that it has a substantial amount of goods that are proving difficult to sell. Average age of inventory
can help purchasing agents make buying decisions and help managers make pricing decisions (e.g.
discounting existing inventory to move product and increase cash flow).The higher a firm’s average
age of inventory, the greater its exposure to obsolescence risk, the risk that the accumulated
products will lose value in a soft market. Average age of inventory is critical in industries with rapid
sales and product cycles (such as technology). If a firm is unable to move inventory, it will take
an inventory write-off charge, meaning that the products were not equivalent to their stated value
on a firm’s balance sheet.

What Does the Receivables Turnover Ratio Tell You?

Companies that maintain accounts receivables are indirectly extending interest-free loans to their
clients since accounts receivable is money owed without interest. If a company generates a sale to a
client, it could extend terms of 30 or 60 days, meaning the client has 30 to 60 days to pay for the
product.

The receivables turnover ratio measures the efficiency with which a company collects on their
receivables or the credit it had extended to its customers. The ratio also measures how many times a
company's receivables are converted to cash in a period. The receivables turnover ratio could be
calculated on an annual, quarterly, or monthly basis.

A High Accounts Receivable Turnover Ratio

A high receivables turnover ratio can indicate that a company’s collection of accounts receivable is
efficient and that the company has a high proportion of quality customers that pay their debts
quickly. A high receivables turnover ratio might also indicate that a company operates on a cash
basis.

A high ratio can also suggest that a company is conservative when it comes to extending credit to its
customers. A conservative credit policy can be beneficial since it could help the company avoid
extending credit to customers who may not be able to pay on time.

On the other hand, if a company’s credit policy is too conservative, it might drive away potential
customers to the competition who will extend them credit. If a company is losing clients or suffering
slow growth, they might be better off loosening their credit policy to improve sales, even though it
might lead to a lower accounts receivable turnover ratio.

A Low Accounts Receivable Turnover Ratio

A low receivables turnover ratio might be due to a company having a poor collection process, bad
credit policies, or customers that are not financially viable or creditworthy.

Typically, a low turnover ratio implies that the company should reassess its credit policies to ensure
the timely collection of its receivables. However, if a company with a low ratio improves its
collection process, it might lead to an influx of cash from collecting on old credit or receivables.

Tracking the Receivables Turnover Ratio

A company’s receivables turnover ratio should be monitored and tracked to determine if a trend or
pattern is developing over time. Also, companies can track and correlate the collection of receivables
to earnings to measure the impact the company’s credit practices have on profitability.

For investors, it's important to compare the accounts receivable turnover of multiple companies
within the same industry to get a sense of what's the normal or average turnover ratio for that
sector. If one company has a much higher receivables turnover ratio than the other, it may prove to
be a safer investment.

Interpretation of Accounts Payable Turnover Ratio

The accounts payable turnover ratio indicates to creditors the short-term liquidity, and to that
extent the creditworthiness of the company. A high ratio indicates prompt payment being made to
suppliers for purchases on credit. A high number may be due to suppliers demanding quick
payments, or it may indicate that the company is seeking to take advantage of early payment
discounts or actively working to improve its credit rating.

A low ratio indicates slow payment to suppliers for purchases on credit. This may be due to
favorable credit terms, or it may signal cash flow problems and hence a worsening financial
condition. While a decreasing ratio could indicate a company in financial distress, that may not
necessarily be the case. It might be that the company has successfully managed to negotiate better
payment terms which allow it to make payments less frequently, without any penalty.

A Decreasing Accounts Payable Turnover Ratio

A decreasing turnover ratio indicates that a company is taking longer to pay off its suppliers than in
previous periods. The rate at which a company pays its debts could provide an indication of the
company's financial condition. A decreasing ratio could signal that a company is in financial distress.
Alternatively, a decreasing ratio could also mean the company has negotiated different payment
arrangements with its suppliers.

An Increasing Accounts Payable Turnover Ratio

When the turnover ratio is increasing, the company is paying off suppliers at a faster rate than in
previous periods. An increasing ratio means the company has plenty of cash available to pay off its
short-term debt in a timely manner. As a result, an increasing accounts payable turnover ratio could
be an indication that the company managing its debts and cash flow effectively.

However, an increasing ratio over a long period could also indicate the company is not reinvesting
back into its business, which could result in a lower growth rate and lower earnings for the company
in the long term. Ideally, a company wants to generate enough revenue to pay off its accounts
payable quickly, but not so quickly the company misses out on opportunities because they could use
that money to invest in other endeavors.

Analysis
Since the accounts payable turnover ratio indicates how quickly a company pays off its vendors, it is
used by supplies and creditors to help decide whether or not to grant credit to a business. As with
most liquidity ratios, a higher ratio is almost always more favorable than a lower ratio.

A higher ratio shows suppliers and creditors that the company pays its bills frequently and regularly.
It also implies that new vendors will get paid back quickly. A high turnover ratio can be used to
negotiate favorable credit terms in the future.

As with all ratios, the accounts payable turnover is specific to different industries. Every industry has
a slightly different standard. This ratio is best used to compare similar companies in the same
industry.

What Does ROA Tell You?

Return on assets (ROA), in basic terms, tells you what earnings were generated from invested
capital (assets). ROA for public companies can vary substantially and will be highly dependent on the
industry. This is why when using ROA as a comparative measure, it is best to compare it against a
company's previous ROA numbers or against a similar company's ROA.

The ROA figure gives investors an idea of how effective the company is in converting the money it
invests into net income. The higher the ROA number, the better, because the company is earning
more money on less investment.

Remember total assets is also the sum of its total liabilities and shareholder's equity. Both of these
types of financing are used to fund the operations of the company. Since a company's assets are
either funded by debt or equity, some analysts and investors disregard the cost of acquiring the
asset by adding back interest expense in the formula for ROA.

In other words, the impact of taking more debt is negated by adding back the cost of borrowing to
the net income and using the average assets in a given period as the denominator. Interest expense
is added because the net income amount on the income statement excludes interest expense.

Benefits and Drawbacks of EVA

EVA assesses the performance of a company and its management through the idea that a business is
only profitable when it creates wealth and returns for shareholders, thus requiring performance
above a company's cost of capital.

EVA as a performance indicator is very useful. The calculation shows how and where a company
created wealth, through the inclusion of balance sheet items. This forces managers to be aware of
assets and expenses when making managerial decisions. However, the EVA calculation relies heavily
on the amount of invested capital, and is best used for asset-rich companies that are stable or
mature. Companies with intangible assets, such as technology businesses, may not be good
candidates for an EVA evaluation.

Components of EVA

The equation for EVA shows that there are three key components to a company's EVA: NOPAT, the
amount of capital invested and the WACC. NOPAT can be calculated manually but is normally listed
in a public company's financials. Capital invested is the amount of money used to fund a specific
project. WACC is the average rate of return a company expects to pay its investors; the weights are
derived as a fraction of each financial source in a company's capital structure. WACC can also be
calculated but is normally provided as public record.
 An equation for invested capital often used to calculate EVA is = Total Assets - Current Liabilities, two
figures easily found on a firm's balance sheet. In this case, the formula for EVA is: NOPAT - (Total
Assets - Current Liabilities) * WACC.

The goal of EVA is to quantify the charge, or cost, of investing capital into a certain project or firm
and to then assess whether it generates enough cash to be considered a good investment. The
charge represents the minimum return that investors require to make their investment worthwhile.
A positive EVA shows a project is generating returns in excess of the required minimum return.

Net Operating Profit After Taxes (NOPAT) - Invested Capital * Weighted Average Cost of Capital
(WACC)

ECONOMIC VALUE ADDED EXAMPLE (BASIC)

#1 – EVA FORMULA – NET OPERATING PROFIT AFTER TAX (NOPAT)

This represents how much will be the company’s potential cash earnings without its capital cost. It is
important to deduct tax from the Operating Profit to arrive at the true operating inflow that a
company will earn.

NOPAT = Operating Income x (1 – Tax Rate).

EVA Example for calculating Net Operating Income After Tax is as follows:

ABC Company

Abstract of the Revenue Statement

Year
Particulars
2016 2015

Revenue:

Project Advisory Fees $ 2,00,000 $ 1,86,000

Total Revenue (A) $ 2,00,000 $ 1,86,000

Expenses:

Direct Expenses $ 1,00,000 $ 95,000

Total Operating Expenses (B) $ 1,00,000 $ 95,000

Operating Income (C = A minus B) $ 1,00,000 $ 91,000

Tax Rate 30% 30%

Tax on operating income (D = C * Tax Rate) $ 30,000 $ 27,300

Net Operating Income After Tax (C minus D) $ 70,000 $ 63,700

#2 – EVA FORMULA – CAPITAL INVESTED

This represents the total capital invested through equity or debt in a given company.

Continuing with the above EVA example of ABC Company, let us say the company has a total
invested capital of $ 30,000. Of this $ 20,000 is through equity funding and the rest ($ 10,000) is by
means of long term debt.

Also, have a look at Return on Invested Capital Ratio

#3 – EVA FORMULA – WACC

Weighted Average Cost of Capital is the cost the company incurs for sourcing its funds. The
importance of deducting the cost of capital from the Net Operating Profit is to deduct the
opportunity cost of the capital invested. Formula to calculate the same is as follows:

WACC = RD (1- Tc )*( D / V )+ RE *( E / V )

The formula looks complicated scary but if understood, it is fairly simple. It is much more easier if
the formula is put in words as follows:

Weighted Average Cost of Capital = (Cost of Debt) * (1 – Tax Rate) * (Proportion of debt) + (Cost of
Equity) * (Proportion of equity)

This makes the formula easier to understand and also self-explanatory.

Now, understanding the notations of the formula:

 RD = Cost of Debt

 Tc = Tax Rate

 D = Capital invested in the organization through Debt

 V = Total Value of the firm simply calculated as Debt + Equity

 RE = Cost of Equity

 E = Capital invested in the organization through Equity

An important point to note about this formula is that that Cost of Debt is multiplied by (1 – Tax Rate)
as there is tax saving on interest paid on debt. On the other hand, there is no tax saving on the cost
of equity and hence the tax rate is not taken into account.

Let us now look at how WACC is calculated.

ABC Company

Balance Sheet of the Company

Year
Particulars
2016 2015

$
Equity $ 20,000
17,000

$
Debt $ 10,000
7,000

$
Sources of Funds (A) $ 30,000
24,000

$
Fixed Assets $ 20,000
18,000

$
Current Assets $ 20,000
16,000

$
Less: Current Liabilities $ 10,000
10,000

$
Uses of Funds (B) $ 30,000
24,000

Cost of Debt 8% 8%

Cost of Equity 10% 12%

WACC for the year 2016

 = 8% * (1- 30%) * ($ 10,000 / $ 30,000) + 10% * ($ 20,000 / $ 30,000)

 = (8% * 70% * 1/3) + (10% * 2/3) = 1.867% + 6.667% = = 8.53%

WACC for the year 2015

 = 8% * (1- 30%) * ($ 7,000 / $ 24,000) + 12% * ($ 17,000 / $ 24,000)

  = (8% * 70% * 7/24) + (10% * 17/24) = 1.63% + 8.50% = 10.13%

#4 – ECONOMIC VALUE ADDED EVA CALCULATION

From the above, we have all three factors ready for Economic Value Added calculation for the year
2016 and 2015.

Economic Value Added (EVA) for the year 2016 = Net Operating Profit After Tax – (Capital Invested *
WACC)

 = $ 70,000 – ($ 30,000 * 8.53%)

 = $ 70,000 – $ 2,559 = = $ 67,441

Economic Value Added (EVA) for the year 2015 = Net Operating Profit After Tax – (Capital Invested *
WACC)

 = $ 63,700 – ($ 24,000 * 10.13%)

 = $ 63,700 – $ 2,432 = = $ 61,268

What Does Working Capital Turnover Tell You?

The working capital turnover ratio is calculated by dividing net annual sales by the average amount
of working capital—current assets minus current liabilities—during the same 12-month period. For
example, Company A has $12 million of net sales over the past 12 months. The average working
capital during that time was $2 million. The calculation of its working capital turnover ratio is
$12,000,000 / $2,000,000 = 6.

A high turnover ratio shows that management is being very efficient in using a company’s short-term
assets and liabilities for supporting sales (i.e., it is generating a higher dollar amount of sales for
every dollar of the working capital used). In contrast, a low ratio may indicate that a business is
investing in too many accounts receivable and inventory to support its sales, which could lead to an
excessive amount of bad debts or obsolete inventory.

To gauge just how efficient a company is at using its working capital, analysts also compare working
capital ratios to those of other companies in the same industry and look at how the ratio has been
changing over time. However, such comparisons are meaningless when working capital turns
negative because the working capital turnover ratio then also turns negative.

Working Capital Management

To manage how efficiently they use their working capital, companies use inventory management and
manage accounts receivables and accounts payable. Inventory turnover shows how many times a
company has sold and replaced inventory during a period, and the receivable turnover ratio shows
how effectively it extends credit and collects debts on that credit.

Pros and Cons of High Working Capital Turnover

A high working capital turnover ratio shows a company is running smoothly and has limited need for
additional funding. Money is coming in and flowing out on a regular basis, giving the business
flexibility to spend capital on expansion or inventory. A high ratio may also give the business a
competitive edge over similar companies.
However, an extremely high ratio—typically over 80%—may indicate that a business does not have
enough capital to support its sales growth. Therefore, the company could become insolvent in the
near future. The indicator is especially strong when accounts payable is also very high, which
indicates that the company is having difficulty paying its bills as they come due.

Operating Cycle

Operating cycle is the number of days a company takes in realizing its inventories in cash. It equals
the time taken in selling inventories plus the time taken in recovering cash from trade receivables. It
is called operating cycle because this process of producing/purchasing inventories, selling them,
recovering cash from customers, using that cash to purchase/produce inventories and so on is
repeated as long as the company is in operations.

Operating cycle is a measure of the operating efficiency and working capital management of a
company. A short operating cycle is good as it tells that the company's cash is tied up for a shorter
period.

Another useful measure used to assess the operating efficiency of a company is the cash cycle (also
called the cash conversion cycle).

Formula

Operating Cycle = Days' Sales of Inventory + Days Sales Outstanding

Days sales of inventory equals the average number of days in which a company sells its inventory.
Days sales outstanding on the other hand, is the period in which receivables are realized in cash.

An alternate expanded formula for operating income is as follows:

365 365
Operating Cycle = × Average Inventories + × Average Accounts Receivable
Purchases Credit Sales

Example

Walmart Stores Inc. (NYSE: WMT) is all about inventories. Find its operating cycle assuming all sales
are (a) cash sales and (b) credit sales. You can use cost of revenue as approximate figure for
purchases (i.e. no need to adjust it for changes in inventories).

USD in million

Revenue 469,162

Cost of revenue 352,488

Inventories as at 31 January 2013 43,803

Inventories as at 31 January 2012 40,714

Average inventories 42,259

Accounts receivable as at 31 January 2013 6,768

Accounts receivable as at 31 January 2012 5,937

Average accounts receivable 6,353

Solution

Part (a)
Days taken in converting inventories to accounts receivable = 365/352,488*42,259 = 43.75
Since there are no credit sales, time taken in recovering cash from accounts receivable is zero.
Customers pay cash right away.
Operating cycle is 43.75 days and this represents the time taken in selling inventories.

Part (a)
There is no change in days taken in converting inventories to accounts receivable.
Days taken in converting receivables to cash = 365/469,162*6,353 = 4.92
Operating cycle = days taken in selling + days taken in recovering cash = 43.75 + 4.92 = 48.68
It should be compared with operating cycle of Walmart Competitors, like Amazon, Costco, Target.

Analysis

The cash conversion cycle measures how many days it takes a company to receive cash from a
customer from its initial cash outlay for inventory. For example, a typical retailer buys inventory on
credit from its vendors. When the inventory is purchased, a payable is established, but cash isn’t
actually paid for some time.

The payable is paid within 30 days and the inventory is marketed to customers and eventually sold
to a customer on account. The customer then pays for the inventory within 30 days of purchasing it.

The cash cycle measures the amount of days between paying the vendor for the inventory and when
the retailer actually receives the cash from the customer.

As with most cash flow calculations, smaller or shorter calculations are almost always good. A small
conversion cycle means that a company’s money is tied up in inventory for less time. In other words,
a company with a small conversion cycle can buy inventory, sell it, and receive cash from customers
in less time.

In this way, the cash conversion cycle can be viewed as a sales efficiency calculation. It shows how
quickly and efficiently a company can buy, sell, and collect on its inventory.

Definition

The plowback ratio is the percentage of income that a company reinvests into its own operations. In
other words, it is the percentage of net income that a company does not payout as dividends.

Formula

Plowback ratio = 1-(Total Dividends Paid/Net Income)

1- Dividend payout ratio

What Does the Plowback Ratio Tell You?

The plowback ratio is an indicator of how much profit is retained in a business rather than paid out
to investors. Younger businesses tend to have higher plowback ratios. These faster-growing
companies are more focused on business development. More mature businesses are not as reliant
on reinvesting profit to expand operations. The ratio is 100% for companies that do not pay
dividends, and is zero for companies that pay out their entire net income as dividends.
Use of the plowback ratio is most useful when comparing companies within the same industry.
Different markets require different utilization of profits. For example, it is not uncommon for
technology companies to have a plowback ratio of 1 (that is, 100%). This indicates that no dividends
are issued, and all profits are retained for business growth.

The plowback ratio represents the portion of retained earnings that could potentially be dividends.
Higher retention ratios indicate management’s belief of high growth periods and favorable business
economic conditions. Lower plowback ratio computations indicate a wariness in future business
growth opportunities or satisfaction in current cash holdings.

Investor Preference

The plowback ratio is a useful metric for determining what companies invest in. Investors preferring
cash distributions avoid companies with high plowback ratios. However, companies with higher
plowback ratios could have a greater chance of capital gains, achieved through appreciated stock
prices during the growth of the organization. Investors see stable plowback ratio calculations as
indicators of current stable decision-making that can help shape future expectations.

The ratio is typically higher for growth companies that are experiencing rapid increases in revenues
and profits. A growth company would prefer to plow earnings back into its business if it believes that
it can reward its shareholders by increasing revenues and profits at a faster pace than shareholders
could achieve by investing their dividend receipts.

Impact From Management

Because management determines the dollar amount of dividends to issue, management directly
impacts the plowback ratio. Alternatively, the calculation of the plowback ratio requires the use of
EPS, which is influenced by a company’s choice of accounting method. Therefore, the plowback ratio
is highly influenced by only a few variables within the organization.