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.

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.

17 comments

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  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.

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