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Hello, I'm James, you're watching Accounting Stuff and today we're covering financial ratios.
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I'll explain what financial ratios are, we'll break them down into five main groups,
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and then I'll show you how to work out 25 financial ratios in 25 minutes.
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Ambitious, I know, but we've got this!
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Before we get started, I want to say a big thanks to all my channel members.
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Your support is always appreciated.
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Thank you.
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Financial Statements.
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Financial ratio analysis begins with financial statements.
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Accounting reports that summarize the financial activities and performance of a business.
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The three main financial statements are the income statement, the balance sheet and the cash flow statement.
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However, we can work out most financial ratios using only the income statement and the balance sheet.
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The income statement looks like this.
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It gives us a summary of a business's revenues and expenses over a period of time.
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And then we have the balance sheet which gives us a snapshot of a business's assets,
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liabilities and equity at a point in time.
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So what is financial ratio analysis?
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Good question.
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A ratio tells us how much of one thing we have compared to another thing.
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In a financial ratio we compare the size of one line in a financial statement against another.
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Usually we can find these line items in the income statement
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or the balance sheet and most of the time financial ratios are shown as percentages.
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Whenever that's the case we multiply by 100.
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Financial ratio analysis is the process of comparing different financial ratios over time and across different businesses.
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What types of financial ratio are there?
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I like to break them down into five main groups.
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Profitability ratios, liquidity ratios, efficiency ratios, leverage ratios and price ratios.
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Now, I'll show you how to work out 25 of the most popular financial ratios that live in each of these groups.
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If you want to make some notes, then now might be a good time to grab yourself a pen and paper.
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Or if you'd like to stay focused on this video, I've made some financial ratios cheat sheets that summarize pretty much everything I'm about to cover.
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You can find them on my website.
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The link is down in the description and the proceeds help support this channel.
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We'll kick things off with profitability ratios.
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Profitability ratios measure how efficiently a business generates profit from four different things.
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Revenue, assets, equity and capital employed.
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We can break them down into margin ratios and return ratios.
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Margin ratios measure how well a business converts revenue into profit.
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We can calculate margin ratios using one simple formula.
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profit margin is equal to profit divided by revenue.
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Profit and revenue live in the income statement.
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Revenue is on the top line, it's the earnings that a business generates over a period of time
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and profit is the financial gain left in the business after deducting expenses.
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As you can see there are three types of profit in an income statement.
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Gross profit, operating profit and net profit.
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Gross profit is the big one at the top.
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It's a business's revenue minus its cost of sales.
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And if we take gross profit
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and divide it by revenue then we can find a business's gross profit margin
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which is the first of our 25 financial ratios.
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Gross profit margin tells us how much big profit a business is able to generate from each dollar of revenue earned.
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It's a similar story with the other margin ratios.
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If we move further down the income statement and subtract operating expenses as well then we get to operating profit.
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Operating profit divided by revenue gives us our second financial ratio operating profit margin.
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And if we head down to the bottom line of the income statement we have net profit.
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This is the residual profit that's left over after deducting all of the business's expenses.
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And net profit divided by revenue is, you guessed it, net profit margin, our third margin ratio.
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If you'd like to learn about these in a bit more depth, I've made videos covering each of these ratios.
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I plan to do the same for the rest of the financial ratios in this playlist, so don't forget to subscribe if you'd like to watch those.
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But what about return ratios?
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Return ratios work in a similar way but this time we have net profit on the top of the equation.
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As we saw a moment ago net profit can be found on the bottom line of an income statement.
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In a return ratio we measure how much net profit a business is able to generate relative to its assets,
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equity or capital employed.
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We can find all three of these in the balance sheet.
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Assets make up the left-hand side of a balance sheet.
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Total assets represent all of the stuff that a business owns at a point in time.
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If we take a business's net profit from the income statement and divide it by total assets from the balance sheet,
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then we've calculated its return on assets or ROA.
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Hold up, I want to point out one thing.
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When we compare a line item from the income statement against
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a line item from the balance sheet like we have here it's a good idea to use the average balance sheet number.
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This is
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because the balance sheet is a snapshot at a point in time whereas the income statement covers a period of time.
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If we average the opening and closing balance sheet numbers then we can compare like with like.
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I won't mention this every time it comes up but please keep it in mind.
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On the right hand side of the balance sheet we have liabilities and equity.
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Together these represent the stuff that a business owes.
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A business owes liabilities to third parties and it owes equity back to its owners.
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Total equity is the owner's or shareholder's claim on the net assets of the business.
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And return on equity or ROE is equal to a business's net profit divided by its total equity.
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Return on equity shows us how efficiently a business uses its owner's money to generate bottom line profit.
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But there's a problem.
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Some businesses choose to take out very large loans to fund their operations.
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This reduces the owner's claim on net assets and it can inflate return on equity.
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In these situations it can be better to use capital employed.
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Capital employed is a business's total asset minus its current liabilities.
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It ignores all long-term debt used to fund operations.
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Net profit divided by capital employed is return on capital employed or ROCE.
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ROCY.
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ROCY can even go a step further and use operating profit instead of net profit.
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So return on capital employed is equal to a business's earnings before interest and tax divided by its capital employed.
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At number six, this is our last return ratio and our last profitability ratio.
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Let's move on to liquidity ratios.
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Liquidity ratios measure how well a business can cover its short-term debt obligations using different assets.
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The calculation looks something like this a liquidity ratio is equal to some assets divided by current liabilities
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these assets on the top are used to cover a business's
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short-term debt obligations on the bottom everything you see here can be found on the balance sheet
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which makes things nice
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and simple current liabilities can be found on the right hand side of a balance sheet there are businesses obligations
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that need to be settled within one year.
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On the left we have assets.
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Liquid assets are the stuff that a business owns that can be converted into cash quickly and easily.
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The most liquid asset of them all is cash itself.
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If we take cash and divide it by current liabilities then we have the cash ratio.
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If the cash ratio is bigger than one then a business
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is able to pay off all its short-term debt obligations with the cash that it has on hand.
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This is an indicator of good financial health.
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But it isn't always possible.
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Sometimes we need to look at all of the business's liquid assets on the balance sheet.
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So that means cash, marketable securities like short-term investments and accounts receivable.
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Inventory and prepaid expenses aren't considered to be liquid assets.
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We can find the quick ratio by taking all liquid assets and dividing them by current liabilities.
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This checks if a business can cover its short-term debt obligations using everything that can quickly be converted into cash.
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But we can go a step further too.
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We can consider all of a business's current assets including inventory and prepaid expenses.
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That gives us the current ratio.
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Current assets divided by current liabilities.
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This is our ninth financial ratio and the last of our liquidity ratios.
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Now let's move on to efficiency ratios.
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Efficiency ratios measure how effective a business is at selling inventory to customers,
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how quickly it's able to collect cash back from them and how reliably it pays off its creditors.
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There are two parts to this.
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We have turnover ratios and we have the cash conversion cycle.
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Turnover ratios measure how quickly a business conducts its operations.
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They compare one line from the income statement against a related line in the balance sheet.
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Take the inventory turnover ratio for example.
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In this one we divide cost of goods sold in the income statement by inventory in the balance sheet.
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The inventory turnover ratio tells us how many times a business has sold and replenished its inventory over a period of time.
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The receivables turnover ratio works in a similar way.
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This time we divide revenue in the income statement by accounts receivable in the balance sheet.
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This one measures how efficiently a business collects cash from its customers.
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If we instead divide revenue by total assets from the balance sheet then we also have the asset turnover ratio.
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This one may feel familiar because it's not too different to return on assets, which we covered in profitability ratios.
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That was net profit divided by total assets.
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In this one, however, the asset turnover ratio ignores expenses and focuses on revenue
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and how efficiently a business generates revenue using the stuff it owns.
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Then we have the payables turnover ratio, which is cost of goods sold from the income statement divided by accounts payable in the balance sheet.
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The payables turnover ratio shows us how reliably a business pays off its suppliers.
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It's our last turnover ratio.
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Onward to the cash conversion cycle.
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The cash conversion cycle tells us the average number of days a business needs to convert its investments in inventory into cash.
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It works like this.
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The cash conversion cycle is equal to days sales of inventory plus days sales outstanding plus days payable outstanding.
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These three cash conversion ratios are the upside down of turnover ratios.
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Days sales of inventory is the upside down version of the inventory turnover ratio.
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This time we have inventory from the balance sheet on the top
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and cost of goods sold from the income statement on the bottom.
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But this time round we multiply the ratio by 365, the number of days in a year.
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When we do this we get the average number of days it takes a business to convert its inventory into sales.
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Also known as the inventory turnover period.
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Days sales outstanding is the inverse of the receivables turnover ratio.
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It's accounts receivable from the balance sheet divided by revenue from the income statement.
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When we multiply it by 365 it tells us the receivables collection period.
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The average time it takes a business to collect a payment from a sale in days.
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And last but not least we have days payable outstanding which is basically the payables turnover ratio upside down.
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Days payable outstanding is accounts payable from the balance sheet divided by cost of goods sold from the income statement times 365.
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It's the average payables payment period.
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The number of days it takes a business to pay its bills.
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Days payable outstanding is our 16th financial ratio and closes the loop on the cash conversion cycle.
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How long it takes a business to turn over inventory, collect cash on sales and pay bills.
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Leverage ratios.
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Leverage is when you up your risk by taking on debt in order to maximize your return or reward.
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Leverage ratios can be split out into two categories balance sheet ratios and income statement ratios.
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Leverage ratios in the balance sheet divide total liabilities by total assets or total equity.
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If we take total liabilities
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and divide them by total assets then voila we have the
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debt to assets ratio the dta ratio this tells us how
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much of a business's assets have been financed using debt this ratio considers both short
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and long-term debt obligations if we jump back to total liabilities in the balance sheet
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and divide them this time by total equity then we've got the debt to equity ratio DTE.
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This tells us how much debt a business has for each dollar of equity.
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A business can finance its assets by either borrowing money from third parties or using its owner's own money.
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Raising debt can be helpful since it uses leverage to expand a business
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but it comes with some risk in the form of interest
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which leads us nicely into interest ratios which we can find in the income statement.
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These determine a business's ability to meet its financial obligations.
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We take a type of profit and divide it by a type of interest.
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Both can be found in the income statement.
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The interest coverage ratio compares a business's operating profit against its interest expenses.
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Operating profit is calculated before interest
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so this tells us whether a business has earned enough profit to cover the interest on its debt obligations.
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But being able to cover interest isn't the whole story.
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Total debt service is made up of interest and repayments of the principal, the current portion of long-term debt.
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So it's also worth checking the debt service coverage ratio which is equal to EBITDA divided by total debt service.
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EBITDA is earnings before interest, tax, depreciation and amortization.
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This ratio uses EBITDA instead of operating profit because it excludes depreciation and amortization which are both non-cash expenses.
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It tells us whether a business generates enough profit to service both the interest and principal repayments on its debt.
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And that's a wrap on leverage ratios.
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But don't go anywhere just yet.
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We have one last group to cover.
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Price ratios.
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Price ratios are very important.
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Investors use them in financial analysis to evaluate the share price of a business and determine if it's a worthwhile investment.
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price ratios tend to fall into two groups we have earnings based ratios
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and dividend based ratios we'll start with earnings based ratios you've probably heard of this one earnings per share
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or EPS it's a business's net profit divided by the number
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of common shares outstanding earnings share represents the slice of a business's profit that's allocated to each share of common stock.
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The number of common shares outstanding can be found in the equity section of a business's balance sheet,
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either in the note for common stock or in the line item description.
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And as we've seen, net profit can be found on the bottom line of the income statement.
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Sometimes the EPS calculation is net profit minus preferred dividends divided by common shares outstanding.
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This is because dividends are distributed to preferred shareholders before common shareholders.
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Earnings per share is a useful way to measure profitability, but it doesn't give us the whole picture.
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If we take a business's share price and divide it by its earnings per share,
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then we find its price to earnings ratio also known as the P-E ratio.
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A business's share price can be found quickly online.
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It's the lowest amount you can buy one unit of company stock for.
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In a publicly traded company that's listed on a stock exchange share prices fluctuate constantly and are determined by the market.
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The P-E ratio is share price divided by earnings per share
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so it tells us how much the market is prepared to pay for each dollar of earnings.
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Share prices can be overvalued which can lead to a large price to earnings ratio.
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However, a high P-E ratio could indicate strong future growth.
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Which brings me on to the next financial ratio.
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The price to earnings to growth or PEG ratio.
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This is equal to the price to earnings ratio which we just covered divided by the expected earnings per share growth.
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EPS growth is an estimate and represents the projected annual growth rate in earnings per share.
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So the PEG ratio delves a little deeper into determining an investment's value than the P-E ratio.
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In theory, it tells us if a company's stock is overvalued, undervalued or priced correctly given the expected future growth rate.
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I say in theory because the validity of the PEG ratio is completely dependent on the EPS growth rate,
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which like I mentioned is an estimate.
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Moving on, moving on, what about dividend-based ratios?
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Dividends per share is calculated in a very similar way to earnings per share
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but this time we swap out net profit on the top for dividends paid
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so dps is equal to dividends paid divided by the number
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of common shares outstanding dividends are cash distributions paid out to
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the shareholders of a business over a period of time this makes dividends per share an important ratio
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because dividends are effectively income from an investor's point of view.
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If a business pays out a special dividend, which is a non-recurring extra dividend related to a particular event,
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then we should deduct it when working out dividends per share.
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Another handy formula for investors is the dividend yield ratio.
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In this one we take dividends per share and divide it by the share price of the company.
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This represents the percentage of a business's share price that it tends to pay out in dividends each year.
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And that's our 25th financial ratio.
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However, since you've made it this far, I do have one extra bonus one for you.
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It's called the dividend payout ratio,
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and we calculate it by taking dividends paid and dividing it by the net profit earned over the same period of time.
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This represents the percentage of a business's net profit that's distributed back to the shareholders as a dividend.
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Another useful ratio for investors.
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And at number 26 this is our last price ratio which completes our mind map of financial ratios.
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We covered profitability ratios which measure how efficiently a business generates profit.
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Liquidity ratios which tell us if a business can cover its short-term debt obligations.
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Efficiency ratios which show us how quick they are at selling inventory, collecting cash and paying off creditors.
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And then there was leverage ratios
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which measure how much debt a business has taken on and its ability to service that debt.
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And finally price ratios are used by investors to evaluate the share price of a business to see
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if it's a worthwhile investment.
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OMG that was a lot to take in.
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I've summarized all this information in my financial ratios cheat sheets.
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If you think they could come in handy then you can find them on my website
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and I will see you in the next video.
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Vocabolario e note di pronuncia per questa lezione
Questo video contiene 250 frasi e 3264 parole da ripetere con lo shadowing. Il parlato dura 23:56. Chi parla mantiene un ritmo costante di circa 136 parole al minuto, comodo per lo shadowing. Solo il 78% delle parole rientra nelle 3.000 più comuni dell’inglese, quindi il lessico è impegnativo.
Vocaboli chiave di questo video
15 parole del video che vale la pena imparare, con pronuncia e significato:
| Parola | Pronuncia | Significato |
|---|---|---|
| ratio sostantivo | /ˈɹeɪ.ʃoʊ/ | ragione, rapporto |
| divide verbo | /dɪˈvaɪd/ | dividere, dividersi |
| asset sostantivo | /ˈæsɛt/ | bene, proprietà |
| sheet sostantivo | /ʃit/ | foglio |
| dividend sostantivo | /ˈdɪvɪdɛnd/ | dividendo |
| earnings sostantivo | guadagno | |
| inventory sostantivo | /ˈɪn.vən.tɹi/ | scorta |
| equity sostantivo | /ˈɛk.wɪ.ti/ | equità, parità |
| turnover sostantivo | /ˈtɝnoʊvɚ/ | giro d'affari |
| liability sostantivo | /laɪəˈbɪlɪti/ | responsabilità |
| margin sostantivo | /ˈmɑɹ.d͡ʒɪn/ | margine |
| expense sostantivo | /ɪkˈspɛns/ | spesa |
| obligation sostantivo | /ˌɑ.blɪˈɡeɪ.ʃn̩/ | vincolo |
| generate verbo | /ˈd͡ʒɛn.ə.ɹeɪt/ | generare |
| employ verbo | /ɪmˈplɔɪ/ | impiegare, ingaggiare |
I phrasal verb che sentirai
| Parola | Pronuncia | Significato |
|---|---|---|
| pay off verbo | corrompere | |
| come up verbo | venire fuori, emergere | |
| hold up verbo | ritardare, rallentare | |
| make up verbo | /ˌmeɪk ˈʌp/ | comporsi |
| point out verbo | additare | |
| take out verbo | cavare, cacciare | |
| turn over verbo | ribaltare, capovolgere |
La grammatica di questo video
Le strutture che chi parla usa di più, con le parole esatte del video:
| Struttura | Nel video |
|---|---|
| Present perfect have/has + participio passato — un’azione passata che conta ancora adesso | have compared · I've made · we've calculated |
| Forma passiva be + participio passato — conta ciò che accade, non chi lo fa | is always appreciated · are shown · can be found |
| Frasi relative who / which + frase — un’informazione in più su una persona o una cosa | ratio, which is · outstanding which is · ratio which is |
Pronuncia a cui fare attenzione
Chi parla usa 29 contrazioni e forme ridotte, come we've, I'll, I've. Pronunciale nella forma breve, così come le senti.
- I suoni “th”: worthwhile /ˌwɜː(ɹ)θˈwaɪl/, ninth /naɪnθ/
- I suoni “sh” e “zh”: ratio /ˈɹeɪ.ʃoʊ/, sheet /ʃit/, obligation /ˌɑ.blɪˈɡeɪ.ʃn̩/, conversion /kənˈvɝʒən/, efficiency /ɪˈfɪʃ.ən.si/
- Parole lunghe — attenzione all’accento: liability /laɪəˈbɪlɪti/, efficiency /ɪˈfɪʃ.ən.si/, indicator /ˈɪn.dɪˌkeɪ.tə(ɹ)/, validity /vəˈlɪd.ɪ.ti/, residual /ɹɪˈzɪd͡ʒ.u.əl/
Come esercitarsi con questo video
- Ascolta tutto il video una volta senza parlare e annota le parole che non conosci.
- Fai shadowing frase per frase a velocità normale, ripetendo ognuna finché il tuo ritmo coincide con quello di chi parla.
- Registrati e confronta con l’originale, facendo attenzione a parole come ratio, divide, asset.
Cos'è la tecnica dello Shadowing?
Shadowing è una tecnica di apprendimento delle lingue supportata da studi scientifici, originariamente sviluppata per la formazione dei traduttori professionisti e resa popolare dal poliglotta Dr. Alexander Arguelles. Il metodo è semplice ma potente: ascolti un audio in inglese di madrelingua e lo ripeti immediatamente ad alta voce — come un'ombra che segue il parlante con un ritardo di solo 1–2 secondi. A differenza dell'ascolto passivo o degli esercizi di grammatica, lo shadowing costringe il tuo cervello e i muscoli della bocca a elaborare e riprodurre simultaneamente i modelli di discorso reale. La ricerca dimostra che migliora significativamente la precisione della pronuncia, l'intonazione, il ritmo, il discorso connesso, la comprensione dell'ascolto e la fluidità del parlato — rendendolo uno dei metodi più efficaci per la preparazione alla prova di speaking dell'IELTS e per la comunicazione reale in inglese.