Financial Ratio Calculation and Analysis

Financial Ratio Calculation and Analysis
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  • 0:03 Financial Ratios
  • 2:00 Profit Margin
  • 2:59 Debt Ratio
  • 4:17 Lesson Summary
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Lesson Transcript
Instructor: Yuanxin (Amy) Yang Alcocer

Amy has a master's degree in secondary education and has taught math at a public charter high school.

After watching this video lesson, you will understand how financial ratios are calculated. You will also understand where they come from and how to read them.

Financial Ratios

Meet Joe. He is a business owner. He owns the local burger place. He makes the best cheeseburgers and fries you have ever known. I mean, his stuff is so good that he has a line out the door no matter what time it is.

Joe, though, being the businessman that he is, not only does the food well, he also takes care of his finances well. Because he is in business, he also understands how important math skills are. He even took a refresher math course just so he can keep his finances in good order. See, what Joe does with his finances is he calculates his financial ratios. These are ratios of important numbers from his financial records. Joe is able to tell how his company is performing by looking at these ratios.

Some examples of the important numbers that he deals with are net profit (how much profit Joe ends up with), net sales (how much sales Joe ends up with), total liabilities (all of Joe's debts), and total assets (how much money Joe's business is worth). Let's see how Joe makes his calculations.

Calculation

To calculate any financial ratio, we take one of our numbers and divide by the other number. Which numbers we choose to use depends on what we want to analyze. If we want to analyze our profit margin, how much of our sales is actual profit, then we would want to divide our net profit by our net sales. This will give us a decimal number, which we can turn into a percentage that will be easy to read and understand. We will look into Joe's profit margin in just a bit.

Another example is the debt ratio, which tells us how much the company is in debt. To calculate this financial ratio, we need to divide our total liabilities by our total assets. This time, again, we will also get a decimal number, which we can turn into a percentage. We will also see Joe's debt ratio in a bit, too.

But first, let's see how Joe calculates his profit margin.

Profit Margin

Do you remember how to calculate the profit margin? We divide our net profit by our net sales. For Joe, he looks through his financial records and he finds that for this past month, his net profit is $20,000, while his net sales are $60,000.

Following the formula for calculating the profit margin, he takes the net profit and he divides it by the net sales. He gets $20,000/$60,000 = 0.333333. Joe gets a decimal answer. Turning this into a percentage, he gets 33.33%.

Looking at this percentage tells Joe that about 33% of his sales ends up being profit for him. This means that he has room to give out coupons and still cover all his costs and expenses. The higher the profit margin, the better it is for the business. It allows the business to take this profit, this extra money, and put it back into the business so it can grow.

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