8.1 – A note on Financial Ratios
Over the last few videos, we have understood how to read financial statements. We will now focus our attention on analyzing these financial statements. The best way to explore financial statements is by studying the ‘Financial Ratios’. Let’s dive in.
In the following video, we will understand how to value a company.
We recommend reading this chapter on Varsity to learn more and understand the concepts in-depth.
Key takeaways from this chapter
- A Financial ratio is a useful financial metric of a company. On its own merit, the ratio conveys very little information
- It is best to study the ratio’s recent trend or compare it with the company’s peers to develop an opinion
- Financial ratios can be categorized into ‘Profitability’, ‘Leverage’, ‘Valuation’, and ‘Operating’ ratios. Each of these categories gives the analyst a certain view on the company’s business.
- EBITDA is the amount of money the company makes after subtracting the operational expenses of the company from its operating revenue
- PAT margin gives the overall profitability of the firm
- Return on Equity (ROE) is a precious ratio. It indicates how much return the shareholders are making over their initial investment in the company
- A high ROE and high debt is not a great sign
- Return on Assets is an indicator of how efficiently the company is utilizing its assets
- Return on Capital employed indicates the overall return the company generates considering both the equity and debt.
- For the ratios to be useful, it should be analyzed compared to other companies in the same industry.