Santikian_FBE421_PMarginsCStructureRisk - F BE 421 F...

FBE 421:
Financial Analysis
& Valuation
Profit Margins, Cost Structure and
Cash Flow Risk

Questions
•
How do profit margins and the cost structure
affect the risk of firms’ cash flows?
•
Do higher profit margins lead to more or less
risky cash flows?
•
Do variable costs influence the risk of cash flows?
•
Do fixed costs influence the risk of cash flows?

Profit Margins and Cost
Structure
•
We need to understand how these factors affect the
risk of cash flows.
•
This will determine the risk of the business and
influence multiples.
•
Important for choosing and analyzing comparables.

Example
•
Imagine we are analyzing oil companies.
•
Suppose their revenues move together with oil prices
(when oil prices increase 1%, their revenues increase
1%).
•
Oil price risk is a major source of risk for companies.

First Scenario
•
Suppose that the major costs of these companies are
fixed – i.e., costs do not change much with oil prices.