Module 3   Fundamental Analysis (Video Series)Chapter 8

# The Financial Ratio Analysis

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## 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.

### 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.

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.

• Karthik Rangappa says:

Thanks, Mihir. Not sure if we can do the edits now, but will certainly try.

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:

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

• Karthik Rangappa says:

Welcome!

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?

• Karthik Rangappa says:

Shareholders Equity = Share capital + Reserves + surplus.

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

• Karthik Rangappa says:

Must be a typo, Manvi. You can cross-check from the annual report actually.

11. Preeti Sankaran says:

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

• Karthik Rangappa says:

Pretty much the same, Preeti.

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 ?

• Karthik Rangappa says:

I need to double-check the numbers again, maybe. Could be a typo.

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