We recommend reading this chapter on Varsity to learn more and understand the concepts in-depth.


Key takeaways from this chapter

  1. A Financial ratio is a useful financial metric of a company. On its own merit, the ratio conveys very little information
  2. It is best to study the ratio’s recent trend or compare it with the company’s peers to develop an opinion
  3. 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.
  4. EBITDA is the amount of money the company makes after subtracting the operational expenses of the company from its operating revenue
  5. PAT margin gives the overall profitability of the firm
  6. Return on Equity (ROE) is a precious ratio. It indicates how much return the shareholders are making over their initial investment in the company
  7. A high ROE and high debt is not a great sign
  8. Return on Assets is an indicator of how efficiently the company is utilizing its assets
  9. Return on Capital employed indicates the overall return the company generates considering both the equity and debt.
  10. For the ratios to be useful, it should be analyzed compared to other companies in the same industry.

46 comments

  1. Mihir says:

    Great content keep it up !!! Was also reader of varsity, but videos are very insightful and easy to understand. Just one recommendation, please put varsity logo at end of video on left or right so viewer can read the “Key takeaway” section.

  2. Sudharma says:

    Very helpful content. Thanks lot Karthik for making this available for free. It’s truly valuable. I was reading the ROCE and I did not understand why
    ROCE = [Profit before Interest & Taxes / Overall Capital Employed] and why not ROCE = [PAT / Overall Capital Employed].

    Thank you.

    • Karthik Rangappa says:

      The idea is to get a sense of return from both the assets and liabilities, without really considering the effect of financial charges and taxes.

  3. Tyson says:

    Please elaborate the subject

  4. manish says:

    while calculating EBITDA in video series you just substract total income from total expanse but the 2014 written module u first minus other income and minus finance cost and depreciation &amortization and than calculated EBITDA . why it is changed now ?

    • Karthik Rangappa says:

      It is not changed 🙂

      These are two different methods. The one in the video series is generic and widely used.

  5. Shweta says:

    Should we use EBIT or EBITDA? Why are we not taking depreciation and amortization into account? As per Warren Buffett, ignoring the above doesn’t provide the correct picture.

    • Karthik Rangappa says:

      It really depends on the individual analyst, Shweta. Some prefer EBIT as they consider D&A as just accounting entries, while others like to consider D&A. You need to find what works for you.

  6. Shreyank says:

    Hi sir, I was calculating EBITDA for a company using formula EBIDTA = Operating Revenue – Operating Expense, where Operating Revenue = Total Income – Other Income and Operating Expense = Total Expense – Finance Cost – Depreciation and Amortization as these formula stated in Varsity Fundamental Analysis Chapter Based module of Financial Ratio part 1 . So, the issue here is the EBITDA , I got was not matching with the company’s EBIDTA stated in their P&L Sheet and their was a big difference in EBITDA Margin which I got around 26.15% and according to company’s Annual Report EBITDA it was around 23.04%. The report used only the difference between total revenue and total expense to calculate EBITDA.
    So , I want to know why there is a difference between these two and which one of the EBITDA is accurate or correct?
    P.S – If you need company’s report and name to analyze yourself, I will send you.

    • Karthik Rangappa says:

      Sheryank, the more accepted formula for EBITDA is Total Revenue – Total expenses. I guess you can use this only and not whats stated in Varsity.

  7. Shreyank says:

    Ok Thank You

  8. Shrey says:

    Sir, what is shareholder equity and where can I get the value of shareholder equity. Websites like Investopedia and other popular financial site show shareholder equity = Total Assets- Total Liabilities but we know total assets = total liabilities that means Shareholder Equity = 0.
    How can this be possible?

  9. Adi says:

    Sir, what do we mean by revaluation reserves, which is used while calculating P/BV ratio. And where can I find it’s value. I tried searching in the associated note but it did’nt mention anyting related with revaluation ratio.

    • Karthik Rangappa says:

      Revaluation reserves are basically a reserve earmarked against a certain asset, whose value is maybe market-linked and volatile in nature. You just have to exclude the revaluation reserve from reserves when calculating the book value.

  10. manvi says:

    while calculation EBITDA of bajaj auto, the total income is 31,443.2 amd total expenditure is 25,072.6 so the difference is 6,370.6 but you have written 6,692.1

  11. Preeti Sankaran says:

    Hi Karthik. I don’t understand what is the difference between OPM and EBITDA margin.

  12. vintage says:

    In this line “Net Profit Margin: As I mentioned earlier, this is same as the PAT margin. From our
    calculation earlier, we know the Net Profit Margin for ARBL is 9.2%” , the NET profit margin is pAT margin which as per our calculation is 10.5 .. how did we get 9.2 ?

  13. Udhav says:

    Hi, what is considered to be a high Price to book ratio and vice-versa?

  14. Vikash says:

    Dear sir
    How to find out total outstanding shares in the market

  15. Anirban Basak says:

    Sir,

    While calculating PAT margin in page no: 83, we took PAT (=367)/Total revenue(=3482)=10.5%
    Then we knew that PAT margin and Net profit margin are indifferent from page no:86. However, Net margin figure given as 9.2% in Page no:86. Can you please help understand?

    Again, Asset turnover= Net sales/ Avg. total cost and net sales figure is taken as “Revenue from Operating sources” only. Is it true that Net sales figure should be taken as Revenue from operating sources only and not from any other sources. If this is true, then is it that Net sales figure while calculating Net profit margin should take revenue from all sources and net sales figure while calculating asset turnover will only consider figure of revenue from operating sources only. Please help.

    • Karthik Rangappa says:

      Anirban, so in Net you can exclude the ‘other income part’,

      The general idea with all these ratios is to find out the company’s operating efficiency by considering only the revenue from operations and excluding other income. Of course, one can argue that other income is also an income to the company and should be factored in with the same seriousness, but in the end, it depends on the analysts looking at this. I’d personally like to exclude the other income part and consider only the operating income.

  16. Khan says:

    Hi,

    The content of the video gave a brief idea on evaluation ratios.

    is it possible to provide a detailed example on each section which can help to conclude wheather to buy a stock or no please.

    Thanks
    Khan

  17. Saravana says:

    How to known the out standing shares of a company?

  18. abhishek says:

    how can you calculate the outstanding per . I can’t understand could you help me to.

  19. Dhruv says:

    this are very valuable and thank you for providing good knowledge. i want to know in calculating sales per share ratio how did you put total numbers of share outstanding in the market. what is share outstanding in the market?

    • Karthik Rangappa says:

      These are shares issued, Dhruv. Keep an eye on our Youtube channel, we are pushing a video on this topic soon 🙂

  20. Umaer says:

    could you please explain more details on Earning per share and Sales Per share…

    Also I could see in the video why is revenues from contracts with customer is considered as total sales… to calculate sales per share.

  21. Sundar says:

    Sir p/b ratio and p/E what ratio is good to buy the share

  22. Surya says:

    In sales per share calculation, how to know total outstanding shares in the market ?

    • Karthik Rangappa says:

      You can look at the share capital of the firm, divide that by the face value to get the number of shares.

  23. Sanket says:

    Thank you so much for the amazing content, especially the part where you have included actual Annual reports of organisations as well as examples from NSE. Can you please share the link from where you have checked P/B, P/E ratios on the NSE website?

  24. IB says:

    How do we know if the price to book ratio is higher or lower?any specified level or number above or below which we can know ?

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