Understanding Key Financial Ratios

Video Transcript

"My name is Miranda Chook, a CPA. There are many ways to analyze a financial ratio statement and ratios are one way of doing this. There are many different ratios and they also differ by industry in terms of which are more relevant and others. So in this segment we'll talk about a few of the more common ratios that do go across industries and build on more complex ones later on. One that's quite popular and quite common is the gross margin ratio or the gross margin percentage and this is calculated by taking the dollar amount of the gross margin and dividing it by sales. In general, the higher the better because that means that there are revenues in excess of expenses to produce and store the product, that are, is available to pay for other expenses such as salaries or and the taxes. Now the ratio by itself isn't necessarily meaningful because certain ratios in the seventy percent range for example are very good for one industry; but will raise eyebrows in another industry and the ratios of thirty percent are very good, but, but certainly indicate a problem with a company in another industry. Now a couple of other ratios that are quite common are the return on equity and return on assets. The return on equity can be calculated as net income divided by average shareholders equity. And average shareholders equity can be calculated simply by taking the balance of shareholders equity at the beginning of the period and at the ending of the period and divide by two. The other ratio, return on assets is calculated by taking net income and dividing it by average total assets. Again, the average total assets can be calculated by taking the total assets at the beginning of the period and the ending of the period and dividing by two. Return on assets is one indication of management performance in managing a company's assets in terms of how well the company is performing and this is an example of the ratio that actually be further disaggregated into different components like inventory turnover and receivables turnover. So again remember that these ratios do need context to be meaningful and actionable. If you can, take a look at these ratios and compares into prior periods and in relation to forecast of the company itself actually maybe publishing. Also know what industry you're dealing with and compare the ratios to other companies within the industry and this, and this company's competitors."