CFO Skills: Mastering Financial Ratios & Financial Statements

1. Welcome Aboard!: Hi. I'm Danish misha. You'll be hearing this voice throughout the course, guiding you step by step on your journey to mastering financial ratios. With years of experience in finance, I'm here to simplify the complexities and help you excel. Are you overwhelmed by endless spreadsheets and struggling to make sense of financial data? Is all this causing you headaches and stress? Don't worry. I've got you covered. In this course, I'll be your mentor, turning confusion into clarity. My reach spans across the globe, and I'm proud to say that most of my students hail from the United States. You'll be joining an international community of learners who are already transforming the way they understand and manage finances. Don't just take my word for it. Have a look at my reviews. Students rave about the clarity, depth, and practical approach of my teaching. They've called this course a game changer for their careers and businesses. See for yourself why I'm the go to mentor. My course is your secret weapon. You'll unlock the ability to understand and apply essential financial ratios, empowering you to analyze performance, identify opportunities, and drive success in your business or career. Here's what we'll cover profitability ratios, liquidity ratios, efficiency ratios, leverage ratios, and market ratios. Every concept is explained with practical examples you can relate to. Who is this course for? This course is designed for students of finance, entrepreneurs, small business owners, investors, and professionals looking to enhance their skills. No matter your background, if you're ready to make informed financial decisions, this course is your gateway. Here's why you should enroll. You'll master financial ratios like a professional, beat the calculations, beat the analysis, that would be a piece of cake. You'll build confidence in your financial expertise, make data driven business decisions and gain the tools to analyze real world financial scenarios. Plus, you'll position yourself for growth and success. So what are you waiting for? Take the leap today, enroll now, and start unlocking the power of financial ratios. Your journey to financial master restarts here. Let's get started together. 2. Introduction to Ratios: Hi, everyone. In this course, we'll explore the fascinating world of financial ratios, key tools that help us measure and understand a business's financial health. So financial ratios are grouped into five key categories. The first profitability ratios. These ratios assess a company's ability to generate profit relative to revenue, assets or equity. Moving on, we'll cover liquidity ratios. They evaluate a company's ability to meet their short term financial obligations. Furthermore, efficiency ratios, they measure how effectively a company uses its resources like assets and inventory. Moving on, we'll cover market ratios. These ratios provide insights into company's market valuation and investor perceptions. And finally, we'll conclude with leverage ratios. They help analyze a company's use of debt to finance its operations. So, guys, throughout this course, we'll break down each ratio, explain how they calculate it, and show you how to interpret the results for smarter financial decision making. So buckle up and see you in the next video. Thank you very much. 3. Importance of Ratios: Hi, everyone. Welcome to the importance of financial ratios. Financial ratios play a crucial role in decision making for various stakeholders. Let's see why they matter. Number one, performance evaluation. Ratios provide insights into a company's profitability, efficiency, and overall performance. So think of them as a scorecard, helping companies evaluate how well the company is performing in key areas. Number two, managers can assess whether the business is meeting its financial goals, and how can a manager do that by regularly tracking these ratios? Managers can see if goals are being met, and if not, they could take corrective action. Moving on financial health assessment. Liquidity ratios like the current ratio, help determine if a company is able to meet its short term obligations. So liquidity ratios are very, very important. We'll cover the current ratio and quick ratio. They provide a snapshot of whether a company can pay its short term debts using its current assets, such as cash, money in the bank, receivables, inventory, et cetera. Number two, leverage ratios reveal the level of financial risk associated with debt. And how is that possible? They show us how much of the company is financed through debt and how much is financed through equity. Now, that's crucial for the company's financial stability, especially in times of uncertainty. Moving on, investment decisions. Market ratios such as the price earnings ratio and earnings per share guide investors in evaluating the value of their investments. So these ratios provide clarity on whether a company is a good investment opportunity or not, whether the company is overvalued or undervalued, whether the investors should buy, hold, or sell their stocks. Number two, investors, obviously, they can use these ratios to compare companies in the same industry. They allow investors to compare the value of different companies and decide which company to allocate their funds. Furthermore, operational efficiency efficiency ratios highlight how effectively a company is using its resources such as inventory and assets. For instance, this is a very important ratio will cover later the inventory turnover ratio. That shows how quickly a business sells and replaces its stock, which is key for avoiding overstocking or stockouts. Also, they help identify areas for cost deduction and process improvement. Moving on credit worthiness evaluation, Creditors or lenders, they use financial ratios to determine whether to extend credit or loans to a company. They can assess whether the company is a safe bet for loans or not. We'll cover a very important ratio later on the debt to equity ratio. Now, debt to equity ratio can reveal whether the company is over leveraged, which increases the risk of default, meaning that it's very risky to provide a loan to such a company. They might not repay the loan. Furthermore, benchmarking and comparisons, ratios enable businesses to benchmark performance against competitors or industry standards. Now, always remember one thing, financial ratios are not just about analysing one company. They allow us to compute the performance against competitors and industry standards. For instance, if a company has a higher profit margin, it may signal better cost management. They're probably better than us in pricing strategies as well. This helps in identifying competitive strengths and weaknesses. Like, it could show us where a company is excelling and where it needs to improve in order to stay competitive. Finally, strategic planning. By analysing trends in financial ratios over time, companies can make informed decisions about growth, expansion, et cetera. Ratios are not just tools for the present. Remember that. They can also help guide future decisions and strategies. Number two, ratios help prioritize areas for improvement to achieve long term success. By analyzing the trends in the key ratios, companies can identify whether they're ready for expansion, whether they require cost reduction, should they explore new avenues for investments. Okay? So financial ratios, they act as a roadmap. They would align decisions with the long term goals to ensure the resources are allocated efficiently. So, guys, thank you so much. It was a pleasure. I'll see you in the next video. Bye. 4. What is Liquidity?: Hi, everyone. Today, we would be discussing liquidity. Liquidity is the ease with which a company can convert the assets into cash in order to cover short term obligations. Every business entity, they have short term obligations. For instance, repaying loans, repaying your lenders, covering day to day bills, salaries, and other operating expenses. So how easy or how comfortable or how convenient would it be for the company in order to utilize all their current assets in paying their short term liabilities? That's known as liquidity. Now, I mentioned the word current assets. So let's see how current assets can be used to pay off short term obligations. Number one, we have cash. Now, cash is the highest or the most liquid asset because it's already in the form needed to pay your obligations. For instance, if your accounts payable or your lender visits your office, you can easily give him the cash you have in hand or any petty cash you have in your wallet. Second, there's accounts receivable. Now, this is moderately liquid. So the money owed to the company by customers for goods or services provided on credit, receivables are moderately liquid because they depend on the customer's payment timing. For instance, if your customer pays you within 30 days or within 60 days or within 90 days, you would get your cash after that time period. Then you can use that cash to pay off your short term obligations. Then we have inventory. Now, inventory is the least liquid. The reason is because they must first be sold and even to sell your inventory would be very difficult. You would have to market your product, you have to make sure it has sufficient demand. So there are a lot of things you have to take into account. So unsold stock may take weeks or months to sell, and especially if demand is low, then obviously, you would have to work really, really harder. Now, let's see the importance of liquidity for a business. So first, it ensures financial stability. A company with good liquidity can handle unexpected expenses or emergencies, avoiding disruptions in operations, helps to maintain operational flow. So sufficient liquidity allows companies to pay their suppliers, employees, and creditors on time. Improves credit worthiness. Remember, a liquid business is more likely to secure loans. The reason is because their financial health is quite strong and they would have a lower risk of default. Enables strategic opportunities. Liquidity gives companies the flexibility to seize growth opportunities, such as, you know, expanding, investing in new projects, or acquiring other businesses. Also prevents loss of reputation. Now, just imagine, for instance, you own a hotel and different head of states are in the hotel and there's a major conference going on. All of a sudden, your lenders, the banks, they all start protesting outside the hotel. They're demanding to be repaid ASAP. Obviously, your reputation would be tarnished. So failing to meet financial obligations on time, it can definitely damage your reputation and also lead to a lack of trust from all the stakeholders. Right. I'll see you in the next class. Thank you very much. 5. The Current Ratio: Hi, everyone. Today, we would cover the current ratio. The current ratio is a financial metric used to evaluate a company's ability to pay off its short term liabilities using its short term assets. Now, short term liabilities are also known as current liabilities. They are debts or obligations that need to be settled within one year, and short term assets are also known as current assets. These are assets that can be converted into cash or used up within a year. Now, if you still don't understand the concept of current assets and curt liabilities, I prepared a beginners accounting boot camp. The link is in the description of this video. Right. Moving on, let's see the formula and calculation of the current ratio. Now, the formula is very simple. It's current assets divided by current liabilities. Now, let's have a look at the examples of current assets. Cash is the most liquid current asset or even bank. That's also the most liquid asset after cash. Then after bank, we have our debtors, also known as accounts receivable. They are also your current assets, and they are moderately liquid, as we saw in the first video. And stock, your inventory. These are also current assets, and they are the least liquid because they take the most time to convert into cash. Now, under current liabilities, we have loans. We have your creditors, also known as accounts payable, your suppliers to whom you owe money. They are also your current liabilities. And any bank overdrafts. Now, bank overdrafts are basically the extra amount withdrawn from your balance in your account so that additional amount would have to be returned to the bank. Now, let's have a look at an example and let's see. So example is current assets are worth $55,000. Current liabilities are worth $35,000. Now, let's just apply this in the formula. Current assets divided by current liabilities. So 55000/35000, you get 1.57. Okay? Now, what does this 1.57 tell us? Let's have a look. So 1.57 means that for every $1 of short term liabilities, the company XYZ limited they have 1.5 $7 in assets to cover the short term liabilities. So this seems pretty good, right? You have $1 of debt, and in order to pay it, you have 1.5 $7 in current assets. So this is generally considered healthy because the company has enough short term assets to pay the short term debts with some cushion and in their comfort zone as well. Now, let's see something else. Let's interpret the results. So if your current ratio is more than two, that's considered as extremely high. Now, it seems pretty good, right? Your answer is very high. You have a lot of assets, but that's not the case. Maybe you have so much unsold inventory that's being rotten in your warehouse and that's being included in your answer. And maybe you're only selling on credit. So because of a lot of receivables, that value is being reflected in your current ratio. Or, you have too much cash. Now, holding too much cash is not a good thing. You could invest that somewhere, or you could pay dividends with that. And if your current ratio is less than one, that's very dangerous. You have to worry about that because this would signal potential liquidity problems. Probably you have low cash inflows, probably there's no demand of your products. They're not being sold and your receivables are not paying on time. Probably your credit control is very poor. Now, what's the ideal current ratio? Sorry. Ideal current ratio would be around 1.5, like 1.2, 1.3, 1.4, up to 1.5, that would be the ideal current ratio. This means that the company is efficiently using the assets in order to generate returns. If they have extra cash, they're investing it somewhere. They're not holding too much inventory. They're not selling all goods on credit. They have good credit controls. However, before I conclude the class, you must remember that the current ratio would depend from company to company. Like, the ideal current ratio can vary by the industry. For example, companies in industries with longer product cycles, they might have lower current ratios. While service companies, they might maintain higher current ratios due to lower inventory needs. See you guys in the next video. Thank you very much. 6. The Quick Ratio: Everyone. Today, we would cover quick ratio. Now, quick ratio is also known as asset test ratio. It is a more stringent measure of a company's liquidity than the current ratio. So in the quick ratio, we focus on the quick assets. They are the most liquid assets. So the least liquid assets are inventory and prepaid expenses. So let's see why do we remove inventory from the formula? Well, number one, there's no guarantee of sale. You bought products for resale purposes, but obviously, there's no guarantee, right? I mean, you bought something. What if it doesn't get sold due to any reason? The second reason is demand can change. Demand is not fixed. Preferences and tastes and habits constantly change. And if they pull away from you, then obviously your products wouldn't be sold. The third reason is selling inventory requires extensive marketing strategies. You would have to offer discounts, promotions. You have to look at your pricing strategies and many other factors. And lastly, returns are extremely common. If you sold something to a customer, he claims a refund, you would have to give all the cash back. And if you sold on credit, the customer returns the product, so he would not get any cash in return. So these are all the reasons why we have to remove inventory. But why do we remove prepaid expenses from the formula? Well, first, understand what are prepaid expenses. So prepaid expenses, they represent payments made for goods or services that would be received in the future. For example, if you pay insurance premium for the entire year at the beginning of the year, you could use the services and indemnify yourself for the entire year. So if you pay advanced rent for the entire year, so you could use the property for the entire year without paying monthly rentals. So let's have a look at the reasons why we remove prepaid expenses from the formula. Well, lack of immediate cash value. So prepaid expenses represent a future benefit, not cash or an asset that can be quickly converted into cash. For example, if a company has prepaid insurance for the year, that amount cannot be sold or liquidated to raise cash quickly. It only represents an amount the company will use in the future. Secondly, it's a totally non liquid item. So liquidity refers to how easily an asset can be converted into cash. Prepaid expenses are typically not liquid because the benefit from them is realized over time. Lastly, no impact on debt repayment. Quick ratio aims to determine whether a company can meet their short term obligations using the most liquid assets. Since prepaid expenses aren't available for use in the short term, they are totally excluded from the quick ratio calculation. And guys, most commonly, just think about something pretty obvious. In the event of a liquidity crisis, would prepaid expenses help you? No, because they don't generate immediate cash. Right. Now, let's have a look at the formula and calculation. So the formula is current assets minus stock or inventory minus prepaid expenses divided by current liabilities. The entire numerator, you could just write quick assets. So we took all the quick assets on top. For example, let's say your current assets are worth $42,000, inventory worth $20,000, prepaid expenses, $2,000 and current liabilities, $23,000. So let's solve the question. We would write current assets minus stock, minus prepaid expenses divided by current liabilities. So 42,000 -20,000 -2000/20 $3,000, the answer you get is 0.87. Wow, that's less than one. So 0.87 means that the company only has $0.87 in quick assets for every dollar of current liabilities. This is a very dangerous situation. They don't have enough liquid assets to cover the short term obligations. Now, let's interpret the values. Now, if your answer is more than one, two, three, four, five, whatever, that's the perfect situation. This means you have sufficient liquid assets to cover your short term obligations. This is a sign of financial stability. Secondly, if you're one. If your answer is one, that means you're in a break even situation. Now, this is also an alarming situation. You are in the borderline of disaster. So this means that your company just has enough quick assets to cover the short term liabilities, you have to work harder. But if you answer is less than one, then I would say rest in peace. This suggests that the company does not have enough quick assets to cover the curt liabilities, and this could indicate a potential liquidity issue and it could also lead to bankruptcy. So, guys, thank you so much for watching. I'll see you in the next video. 7. The Gross Profit Margin: Hi, everyone. Today we are discussing the gross profit margin. Let's get started. The gross profit margin is a financial metric that shows how efficiently a company produces goods or delivers services while controlling its production costs. It represents the percentage of revenue remaining after deducting the cost of goods sold. Now, I want you to understand what is cost of goods sold. When a company buys inventory to resell, what's the cost of all those items? It could, like, for example, if you're selling ice cream, so what's the cost of producing that ice cream? If you're selling furniture, what's the cost of buying that furniture, the cost of the sofas, the cost of the beds, the cost of the chandeliers, the cost of the decoration. What's the cost of the items we are reselling? Or if you're producing something, what's the cost of producing those items? We only focus on the direct expenses. We totally ignore all indirect expenses that are not related to the product itself. Okay? So in cost of goods sold, we focus on inventory alone, nothing else. Everything related to the inventory would come in the cost of goods sold. So in order to enhance your understanding, I prepared an example, the person you see on the screen is Sara. She runs a small ice cream parlor. So let's see her financials. She sells an ice cream for $5, and the cost of milk was $1 per ice cream. The cost of a cone was $0.50 per ice cream. Cost of sugar was $0.50 per ice cream as well. Cost of culling agents was $0.30 per ice cream. And finally, cost of ice cream essence was $0.40 per ice cream. Remarkably, at the end of the day, she sold 30 ice cream cones. So if I ask you calculate the gross profit. What I'm asking you calculate that level of return she gets after deducting all her direct expenses. So the answer would be $69. And how did I get $69? Sarah sold 30 ice creams. She sells one ice cream cone for $5, multiply both. Add up all the cost of the ingredients, multiply it by 30 ice creams, so you'll get your direct costs. So $69 is the profit left by Sara. Now notice something. We did not account for any expenses such as rent. What's the rent of this ice cream parlor? Any discounts given to customers at this ice cream parlor. Any electricity costs involved. And if she hired a few other workers, their salaries are also not involved. And if she delivers ice cream to her customers, the delivery is not involved. We only accounted for direct costs. This is the gross profit. So now let's see the formula of gross profit, and we would see what does the $69 show? Right. So the formula would be gross profit divided by sales multiplied by 100. Very simple. Now we'll use the same values from the Sara example. So she earned a gross profit of $69. Her revenue was $150. Multiply by 100, you get 46%. Her gross profit margin is 46%. Now, let's interpret this. This means Sara retains 46% of her revenue as gross profit after covering the direct costs of producing ice cream. In other words, we can also say from every $1 of revenue, $0.46 or $0.46 is a gross profit. Also, from every $1 of revenue, 54% is her direct costs, her cost of production, or cost of sales. Okay? So this is the profit she earns after deducting all her direct costs involved in her ice cream or involved in her inventory, okay? So I hope you understood the gross profit margin. See you in the next video. Thank you very much. 8. The Net Profit Margin: Hi, everyone. Today we are discussing the net profit margin. So let's get started. The net profit margin is a financial ratio that measures how much net income or profit a company generates as a percentage of its revenue. It indicates the efficiency of a company in managing its expenses and earning profits from its sales. So first, let's understand what is net profit. In the previous lesson, we discussed gross profit. So in the gross profit, we only subtracted all our direct costs, all costs relating to inventory only. However, in the net profit margin, we subtract all expenses, all costs. We subtract all outflows. We don't care if it's related to the inventory or if it's indirect, as well. We subtract everything. So net profit is basically how much are you taking back at home? How much return are you generating from the business? So the ratio is a percentage just exactly like the gross profit margin. Let's look at an example. A similar example from the previous lesson, we discussed Sara selling ice cream, but the values are slightly modified. Let's assume her sales for the month were $1,000. She earned $1,000 in the month by selling ice cream. And all her direct costs, meaning all the ingredients to produce the ice cream. That amounted to $300. When I mean direct costs, I mean the cost of the inventory. So that was $300. Now there are other costs that are not relating to the ice cream, but they are costs of the business, costs to run the business. For example, electricity. That's a very important cost. She probably has lights over here, and at night, she would use them. So that's $100. She probably hired some helpers, some workers, some sales staff, so she pays them $250. Obviously, marketing is the backbone of a business. Without marketing, how would customers know what she's selling? So that costed her $100, and delivery to customers costed her $110, right? So these are all the expenses of Sara. Now, if I ask you, what's the net income, we would subtract cost of sales and expenses from sales. So we got $140. This is the net profit. In other words, you could also write gross profit minus expenses because sales minus cost of sales is your gross profit anyway. So you could just write gross profit minus expenses, but obviously, to deepen your understanding, I made it easier for you. Now, let's put all this in a formula So the formula is net profit divided by sales into 100. Now, again, putting all in the formula, she earned net profit of $140, revenue of $100 multiplied by 100. So 14% is her net profit margin. Now, let's interpret this 14%. This means that Sara retains 14% of her revenue as net profit after deducting all expenses and direct costs. So if you multiply 14% with the revenue, you'll get your net profit. So 14% times 1,000 would be $140. In other words, Sara is taking $140 back home. That's her return on her investment. Alright? Also, we could also put it this way. 86% of her revenue is all going in her costs and her expenses, right? And only 14%, like a small slice of the pizza, she's taking back home. This is the net profit margin. See you in the next video. Thank you very much. 9. The Return on Equity: Hi, everyone. Today we are discussing a very interesting ratio, the return on equity. Now, what's equity? Let's have a look. Shareholders equity is the residual interest or ownership stake of shareholders in a company's assets after deducting all the liabilities. In other words, it represents the net value of a company that belongs to its shareholders. Now, I want you to understand equity basically means how much stake do you have in a company? How much percentage ownership do you have in a company? You have an interest in the company. You have something to gain. If the company goes well, you'll gain. If the company goes down, you'll lose. So you have a residual interest in the company. Now, there are many things that make up the shareholders equity, but the most important things, let's have a look at the most important things. The first thing is the share capital. Now, Share capital basically represents the money generated by a company by issuing shares. For example, if the share price is $1 and the company issued 10,000 shares, so $10,000 generated is your share capital. Retained earnings, that's also a very important part of the shareholders equity. Retained earnings represents the profit reinvested by the company into the company. So, for example, if the company earned, let's say, $100,000 profit, they paid interest tax, they even paid dividends, so they got $60,000 left. That's what they reinvest in the company, so that's retained earnings. A premium is very important. That's a reserve. So basically, SA premium represents the excess money earned by issue of Shas, for example, if the shape price was $1 and all of a sudden due to high demand, the share price became $5. So the difference between $1.05 dollar, old money generated at the new Share price, that is called SA premium. Also other reserves, for instance, there's the general reserve. There's the foreign exchange reserve. There's the capital replacement reserve. There's devaluation reserve. Reserves have one purpose only to save the company in uncertain and difficult times. Or if the company wants to keep money aside for some specific purpose or any general purpose, so that's where reserves come into play. So all these elements are part of the shareholders equity. And you can find this in the statement of changes in equity. This is where you'll find the equity of shareholders. And remember, this is never fixed. This constantly changes. Equity can go up. If the company does well, equity can go down if the company performs poorly. All right? Now, let's have a look at the formula. Before we move on to the formula, let's see what is the return on equity ratio? What does it show us? So return on equity means how well is the company generating profit by utilizing the funds of the shareholders? Now think for a moment. You invest your money somewhere. And that company would use that investment for business and hopefully generate profit, right? So your money is being used to generate profit. Won't you question the company, how are you using my funds? How well are you doing? Obviously, because your money is at stake and your money is being used for business. So this is exactly what return on equity means. It means, how well is the company making the most of the shareholders investment? This is what the return on equity shows us. Now, let's have a look at a comprehensive example. The formula for return on equity is very simple, net profit divided by shareholder's equity. And when I mean net profit, I mean the profit after interest and tax. When you get your operating profit, you would subtract any interest paid, subtract the tax paid to the government, then you get your profit for the year. Or also known as net profit. This is the value we use in the formula. Now, let's say I look at an example. Let's say profit before interest was $100,000. The interest expense for the year was $1,000. Tex was $2,000, and Shareholders' equity was $450,000. Now let's put this in the formula. So we will use the profit after interest and tax value divided by shareholders equity, multiplied by 100. So in order to get the profit after interest, we have to obviously subtract the interest and tax from the profit before interest. That's exactly what I did over here, $100,000 minus $100, minus $2,000. Shareholders equity is given divided by $450,000, then we'd multiply by 100. We get 21.56%. 21.56%. Now, let's interpret this. What what does this mean? So 21.56% basically means that from every $1 of shareholders equity invested in the company, 0.21 $506 are made in profit. Okay? So this is what the return on equity tells us. Right? Now, when we compare companies, the answer sometimes can be very misleading. Perhaps, they could be companies that are more reliant on debt. Their debt is more than equity. Now, because the equity is low, obviously, the denominator in the formula would be low. So overall, your answer would be high. So sometimes the answers could be very misleading. You have to make sure that you compare companies with similar debt to equity ratios. Their reliance on equity should be similar. The nature of company should be similar as well. So that way you could get a more accurate representation of the return on equity. See you guys in the next video. Thank you very much. 10. The Return on Assets: Everyone. Today, we're discussing another very interesting ratio, known as the return on assets. Very interesting. So let's degrte it. Return on assets is a financial ratio that measures how efficiently a company uses its total assets to generate profit. So basically, in this ratio, we are comparing our assets with our net income because obviously assets in the business, they are used for production. They're used to add value. They have some use in the business which directly or indirectly helps to generate income. So in this ratio, we are going to see how efficiently are the assets being used and how effective are they in generating net income. So before we move on, there are some very important considerations. Many people get confused that what value of our assets do we take in the ratio? So let's have a look. The first important consideration you should know is that always the non current assets would be taken at the netbook values in the formula. If they're tangible assets, we would subtract depreciation. If they are intangible assets, we would subtract amortization. So it's very important to take them at the netbook values. Another very important factor are your receivables. They should be taken at the net values as well. Now, what do I mean by the net value? I mean, you have to subtract any provision for doubtful debts or any unaccounted bad debts. We would have to subtract all those values, then we would use the net value. Another important factor is that in this ratio, we don't select non current acids only. We take all our assets, current and non current, we don't mind. And lastly, we don't consider liquidity. In the liquid ratios, especially in the quick ratio, we subtracted inventory and free payments. We don't subtract anything over here. We don't consider liquid and iliquid assets. We take all of them. Now, let's have a look at the formula straightaway. Net profit divided by your total assets multiplied by 100. And again, when I say net profit, I mean the profit after interest and tax. So you would subtract any interest and tax from our operating profit, then the profit for the year would be used in the calculation. Now, let's have a look at an example. Let's say the profit before interest was $100,000, interest expense for the year, $100, tax payable, $2,000 and total assets worth $350,000. So let's put all the values in the formula. Profit divided by your total assets multiplied by 100. So again, we would subtract our interest tax in the numerator and divide by our total assets, 350,000 multiplied by 100, we get 27.7%. Now, let's try to interpret what 27.7% is trying to tell us means that from every $1 of assets invested in the business, from them, 0.27 $7 are being converted into profit. This is quite a good ratio, okay? 0.27 $7 of property is being made from our $1 of assets. Now this ratio can also become misleading when we compare assets of different companies. Like certain companies, they have heavy machinery. They have lots of non current assets such as airlines, technology and massive manufacturing units. Now, because they have numerous assets, their return on assets would be low because the denominator would be extremely high. So it's very important to compare companies that have similar asset levels. They are in similar stages of production to ensure that your ratio is not misleading. Other important consideration is if you compare the return on assets of older companies, their assets would be lower because of depreciation. They would have charged a lot of depreciation and amortization, but this is not the case with newer companies. So it's also very important to compare companies that have been established in similar years. Lastly, another very important factor is that if you're running a new business and it's the first year of your operations, obviously, you did not yet charge any depreciation. So because of no depreciation, your total assets would be higher and your return on assets as a result would be lower. So it's very important to account for all these factors before compaing your return on assets to ensure you get a more accurate picture of your company. Thank you very much. I'll see you in the next video. 11. Earnings before Interest, Depreciation, Taxes & Amortization (EBIDTA): Hi, everyone. Today we are discussing a key ratio called IBITA. So let's get started. IBTa is also known as earnings before interest, tax depreciation, and amortization. So this is a measure of a company's profitability that focuses on the core operations. All effects that are non operational and non cash, they are removed. So this gives a clearer picture of how well the business is generating profit from its operations. Now, why do we remove interest tax depreciation and amortization? Let's have a look. Let's focus on interest first. Now, understand what is interest. Interest expense is related to how a company is financed. Is it financed through debt or is it financed through equity? Since it reflects the company's financing decisions, it's not part of the co operational performance. So removing interest allows the company to see how well they operate without the influence of its capital structure. Secondly, taxes. Now, taxes are paid to the government based on a company's profits, and the tax liability is influenced by the company's tax policies, jurisdiction, and location. Removing taxes, Abeta provides a clear picture of how well a company performs from a purely operational standpoint, without any influence from tax laws. Thirdly, depreciation. Depreciation is a non cash expense. It does not affect the company's actual cash flow in reality, so it's excluded from IBITA. This allows for focus on operational profitability rather than accounting conventions. Now, if you still don't know why is depreciation, I made a comprehensive and detailed course with 100 practice questions, one practice test, and seven sections. So I'm going to share the link in the description of this video. You can access that course. Lastly, amortization. Now, amortization is exactly like depreciation, but it applies to intangible assets. That's also a non cash expense. It does not affect the actual cash flow, so that's removed from the formula. So basically, all these expenses that you see, they are not the true expenses of a company, which is why they are removed from the formula to give a more reliable estimate to give a more clear picture of the actual financing of a company. Moving on, let's see the formula. So Ibita is equal to net profit plus interest plus tax, plus depreciation and plus amortization. Now, why do we add everything in the formula when it clearly states before interest, depreciation tax, amortization? The reason is net profit is your final figure after subtracting everything, your expenses, interest tax. So we have to add everything back so the value becomes zero and they're officially removed from the formula. Since everything is subtracted, so it's a mathematical rule, minus plus is equal to zero. So in order to remove everything, we have to add everything back. So we remove everything from the accounting records. Now, let's look at an example. Profit after interest is $100,000 interest, $1,000, tax $2,000, depreciation, $30,000, amortization $10,000. So in order to calculate the IBITA it's very simple. You have to just add everything up. So that's exactly what I did, and I got $143,000. Now this $143,000 gives a clearer picture of the company's operating performance. All the financing items, the tax items, non cash items, they're all removed from the value. So now, this is a more reliable estimate. It represents my true expenses. It represents my true core performance items. So I hope you understood Abita. See you in the next video. Thank you very much. 12. The Inventory Turnover: Hi, everyone. Today we are covering inventory turnover, a very important ratio. Now what's inventory? Inventory are the products bought for one intention only, and that's reselling. So inventory turnover is a financial ratio that measures how often a company sells and replaces its inventory during a specific period. It is an important ratio for evaluating the efficiency of a company's inventory management and its ability to convert inventory into sales. In a nutshell, inventory turnover is an indicator of how well a company manages its inventory in relation to sales. Now, if your product is highly demanding, it would get sold in seconds. The shelves would get empty. People will come again and again, so your turnover would be high. On the other hand, if your product is not so demanding, people don't prefer buying your product, so you won't have to replace the shelves very often, so the turnover would be lower. Now, why is inventory turnover important? Well, first, cash flows. A high turnover means inventories being sold quickly turning into cash. Obviously, your liquidity position would become great. Then cost efficiency. Efficient inventory management can reduce costs related to storage, insurance, and spoilage. It allows companies to invest in faster moving inventory, which could improve profitability. Final point, a well managed inventory system often correlates with higher profits as it ensures that inventory is fresh and in demand, minimizing markdowns or wastage. Moving on, let's see the formula, cost of goods sold divided by average inventory. Now, cost of goods sold is the cost of selling your inventory. Whatever products you are stocking up in the shelves, what's the cost of those items? So this consists of opening inventory, the inventory that was unsold in the previous period, what's the cost of those items? Then you bought more inventory. What's the cost of those items? Then we subtract closing inventory. We subtract closing inventory because as the word says, cost of goods sold. Closing inventory are the unsold goods, so we don't include that in our cost. Average inventory is the averages of your opening and closing inventory. Okay? So opening plus closing, divided by two. Let's have a look at an example. Let's say a company has cost of goods sold worth $1 million, opening inventory worth $200,000, closing inventory worth $300,000. So let's put this in the formula. We get 1000000/200000 dollars plus $300,000 divided by two. So the answer we get is four. Okay? So we would present it this way four times. This means the company sold and replaced its inventory four times during the period. Right? Now, how do we know what are the implications of a high inventory turnover or a low inventory turnover? Let's have a look at this. Well, if your inventory turnover is too high, so presumably, it means you are doing a very good thing. Your inventory is being sold quickly, efficiently. People love your product. It can suggest strong sales, effective inventory management, and a lower risk of holding obsolete inventory. Now, high inventory turnover is very common for businesses like retailers because high turnover is usually a good thing for them as it indicates their products are in demand. Secondly, if your turnover is low, this could indicate poor sales, overstocking, low demand, inefficient inventory management, and all this could increase your inventory costs. Now, a low turnover could also indicate that the company has too much inventory and it struggles to sell it all. Now, companies in industries with seasonal sales cycles or luxury goods may naturally have lower turnover. This is what's the important part. A business which has a low inventory turnover does not mean that that's a bad business. If I talk about luxury goods, the turnover won't be as fast as a retailer, like if there's a business selling jets or selling aeroplanes. Now, it's very the time period where airlines place their orders is not so frequent. For example, Emirates Airlines of the United Arab Emirates, they place their orders for the next ten years. So now for the next ten years, Boeing wouldn't get more orders. So if you invent turnover is low, this does not mean you're a bad business. You must compare your business with a business in the same industry. Otherwise, your results would be misleading. See you in the next video. Thank you very much. 13. Receivable days: Hi, everyone. Today we are discussing a simple and interesting ratio, known as the receivable days ratio. It's also known as days sales outstanding ratio, DSO. So let's have a look what this is all about. Receivable is your credit customer to whom you sold goods on credit. Now he owes you money. Okay? The word receivable is linked with the word received. You have to receive money from that person. Now, receivable days calculation measures the average number of days it takes a company to collect the payment after a credit sale. It helps to assess how quickly a company collects cash from customers. So this is totally contingent on your credit control, on your credit policies, on your communication with your receivable. Now, let's have a look at the formula. Pretty simple. We have our average receivables divided by credit sales multiply by the accounting period. If it's a year, then multiply by 365. If it's months, then multiply by 12, if it's weeks, then multiply by 48. Now, average receivables, that means your opening balance of your receivable plus the closing balance of receivable divided by two. The reason why we take the average is because this includes the entire movements that happened in your receivable account. Everything would be accounted for if you take the average of both. Now, let's have a look at an example. Let's say your credit sales are $600,000, opening account receivable $90,000, closing account receivable, $110,000. PDD is 365 days. Now, let's use the formula, average receivables, divided by credit sales, multiply by 365. So let's take the average of the receivables. So $90,000 plus 110000/2 divided by 600,000 of your credit sales, then multiply by 365, you get 61 days, right? So this 61 days basically means that the company takes approximately 61 days to collect payment after a credit sale. It takes them 61 days to receive payment from the credit customers. No, how do we interpret this? How do I know that is the 61 days good or bad? Is it slow or quick? Is it efficient or inefficient? How do I know that? So you have to focus on your credit terms. Credit terms is the agreement your company makes with the credit customers. For example, if the company agreed that the customers should pay within 60 days after a sale, then 61 days is not bad. That's fine. However, if the credit term agreed is 60 days, but the ratio is 90 days, it means that your customers are taking a very long time to pay you the money. It's not good. This could create a liquidity crisis because you're not receiving cash from your customers. You provided a service or you sold goods, but you're not getting cash in return, so that could be problematic for you. It would be a hassle for you to maintain day to day operations of your company because there are many expenses you have to pay many obligations to meet. But if your customers are not paying you cash, that could become problematic. Right. See you in the next video. Thank you very much. 14. Payable Days: One. Today we are discussing the payable days ratio. It's very similar to the previous ratio we discussed receivable days ratio. So let's begin. Now, who's your accounts payable? Accounts payable is your credit supplier. You bought goods on credit from him, now you owe him money or you took services from someone and you are yet to pay him. The word payable and pay are interlinked. Now, payable days measures the average number of days a company takes to pay its suppliers after purchasing goods or rendering services. This metric helps assess the company's payment efficiency and how it manages cash flow. Now the formula is very simple. You take the average payables divided by the cost of sales. I'm sure you know what the cost of sales now, the direct cost of your inventory, the inventory you are selling, the inventory you're selling, what's the cost of those items. Then multiply by 365. So again, average is the opening balance of your payable plus closing balance divided by two. Example, let's say the cost of goods sold is $800,000. You opening balance is $50,000. Closing balance is $70,000, and you have a 365 day period. So let's put it in the formula. So we would take the average $50,000 plus $70,000 divided by two. Cost of sales is given in the question, $800,000, multiply by 365, then you get 28 days. This means the company takes approximately 28 days on average to pay their suppliers. Again, how do I know I this 28 days good or bad? There are two things. Number one, you can compare with your competitors. What is the payable day ratio? But most commonly, if you want to be very efficient and smart, you have to look at the credit terms given by your supplier. Let's assume the agreement with your supplier was that you have to pay within 60 days, but you pay in 70 days. This suggests the company is taking longer to pay. This may improve cash flow, however, it could definitely strain relationship with your suppliers because you're taking longer to pay. However, if the payable day ratio is 40 days, this seems very good, right? But that's not the case. Definitely, it's an indication that the company's paying supply is quicker. Also, supply relationships could be very good. However, this means the company isn't fully using the credit period. If your supplier gave you a 60 day period, then pay within 60 days. Who cares about supply relationships? The main thing is your business. Nothing is more than that. If you have any extra cash, that could be invested somewhere, and it could generate returns. So it's always better to pay your supplier within the credit term he gave you and try to do it as close towards the deadline as possible. Right, guys. I'll see you in the next video. Thank you so much. 15. The Working Capital Turnover: Everyone. Today we are discussing another very interesting ratio, the last of the efficiency ratios, the working capital turnover. Before we begin, let's try to understand what is working capital. So working capital is linked with liquidity. It's a financial metric that represents the difference between a company's current assets and current liabilities. So that's your liquidity. That liquidity would be used to meet short term obligations, to meet operational expenses as well. So obviously, the higher working capital you have, the easier it will be for you to fulfill all these short term obligations. So the capital required for the day to day operations, that's known as working capital. Now, let's see why is working capital important right. So the first is liquidity. Now, there's a difference between positive working capital and negative working capital. Positive working capital is when your current assets are more than your current liabilities. Negative working capital is when your current liabilities are more than your current assets. So liquidity. Remember, positive working capital ensures that the company can meet all their short term obligations without relying on any external financing. Second, operational efficiency, efficiently managed working capital, supports smooth operations and avoids unnecessary cash shortages. Growth potential. Companies with strong working capital can reinvest in their business. They can purchase extra inventory and, of course, take advantage of growth opportunities. Risk indicator. Now, if you're having a negative working capital overtime, this could definitely signal financial distress. It would make it harder to secure loans or attract investors. Coming back to the working capital turnover. Now, this is a ratio that measures how efficiently a company uses its working capital to generate revenue. So basically, we are trying to study the relationship between your sales and your working capital. Let's have a look at the formula now we take the net sales divided by the average working capital. Now, when I say net sales, I mean you have to remove any discounts given to the customers, and you have to adjust any returns by the customers. Now, again, in the denominator, I wrote average working capital, so we'll add the opening working capital plus the closing working capital and divided by two. So when I say working capital, it's simply your current assets minus your current liability. So let's look at an example. Let's say your net sales are $1 million. You opening working capital is $200,000, 500,000 minus $300,000. Your closing working capital is $250,000, which came by subtracting 600,300 $50,000 off your liabilities. So let's put this in the formula. Net sales divided by average working capital. So your net sales are $1 million. Your average working capital would be 200,000 plus 250000/2 you get 4.44 times now, what does this 4.44 times mean? This means the company generates 4.4 $4 in sales for every $1 of working capital. Now, exactly like liquidity, it would be interpreted the same way. If your working capital is too high, then it means that you're holding extra cash, you're holding extra current assets, which could be used in a better purpose. It could be more efficient, and if it's low, then obviously that could signify a liquidity crisis. See you in the next video. Thank you very much. 16. The Debt to Equity Ratio: Hi, everyone. Today, we are discussing a very important ratio, the debt to equity ratio, let's get started. So the debt to equity ratio is a financial metric that evaluates the relationship between a company's total debt and shareholder's equity. So this ratio basically studies how much of the company's operations are financed by borrowed funds, the debt versus the owner's investment, the equity. It's an important measure of a company's financial leverage showing how much debt is used to finance operations compared to the owner's invested capital. So basically, this ratio reflects the company's risk profile and financial stability. Companies with higher debt are seen as riskier due to repayment obligations. Let's move on and see the difference between debt finance and equity finance. So debt finance debt finance refers to borrowing money that must be repaid with interest. So for instance, the company approaches a bank, they could approach bondholders or creditors, and all money borrowed from them would be repaid with a premium known as interest. On the other hand, equity finance is when a company issues shares or stocks, and that's how they raise money. That's known as equity finance. Secondly, debt finance lenders do not gain ownership in the company. They are simply creditors, okay? They are people to whom the company owes money. They don't gain any ownership or stake in the company. On the other hand, equity holders or investors, they become partial owners. So the company gives away shares. Those shares are part ownership of the company. So whoever holds the shares, they become part owners of the company. Thirdly, debt finance requires fixed repayment of principal and interest. So regardless of the company performance, this is a payment obligation that has to be done on a periodic basis. However, in equity finance, there's no repayment obligation. The only thing that investors return return are dividends or capital gains. So dividends are basically like profit shares they attain on the basis of the number of shares they subscribe in the company. Capital gains refers to the appreciation in the shareholder value. The price of the share or stock increases with time. Fourthly, there's no impact on company control. So basically, the ownership dilution is not there. The control is not diluted or the ownership is not diluted either. However, in equity finance, this may reduce control as shareholders, they gain voting rights. They gain ownership, they gain voting rights. Now obviously, as investors, you're investing your money, so you have a say in the company if you own common stock or ordinary shares. Right, moving on. Let's see the interpretation of the debt to equity ratio. So basically, a higher ratio suggests that the company relies heavily on debt. This means that it could lead to higher profits during good times, but increases financial risks, especially if the company faces cash flow issues. On the other hand, a lower ratio implies that the company has a conservative financial strategy. They're relying more on equity. This could prioritize stability and lower risk. Now, let's have a look at the calculation, the formula of the debt to equity ratio. So we take the total liabilities and divide by total shareholders equity. Right? So total liabilities are both your non current and current liabilities. On the other hand, your shareholders' equity, they include your share capital, meaning all money raised by the company when they issued shares or stocks, and all reserves are also added in shareholders' equity. So reserves are basically when the company, they put aside an amount for a general purpose or for a specific purpose. This includes many reserves, for example, the general reserve, retained earnings, revaluation reserve, capital replacement reserve, foreign exchange reserve even share premium. So all those reserves would be added in shareholders' equity. We take our total liabilities, $500,000 and the shareholders equity, $250,000. So we'll apply this in the formula. $500,000 divided by $250,000, we get two. Okay? Now we should understand what does this two mean? It means company A has a debt to equity ratio of two. This means it uses $2 of debt for every $1 of equity. Now, this means that the debt is double the amount of the equity. So the company is significantly leveraged. This could increase profitability for sure. However, financial risk could also increase in case of downturns. Right? Let's have a look at some general guidelines. If your debt to equity ratio is lower than one, that's an extremely safe situation. There's minimal debt obligations. This prioritizes stable, long term growth over rapid expansion, and this would be more appealing to conservative investors. On the other hand, if your ratio is 1-2, that's the moderate category. And this is a balanced approach. This could enable growth while keeping risks manageable, and it indicates effective capital structure management. However, if your ratio is greater than two, then that means you are using debt aggressively to finance growth or operations. No. This could lead to a higher profit potential during good economic situations. However, it could expose the company to significant risk during downturns. And most commonly, the construction industry, real estate, and manufacturing industries fall in this category. Right. See you all the next video. Thank you very much. 17. The Debt to Ebdita: Hi, everyone. Today, we are discussing another very important ratio, the debt to BITA ratio. Let's get started. So the debt to IBITA ratio measures a company's ability to pay off its debt using its IBITA earnings before interest, taxes, depreciation, and amortization. Now, I made a video on bita in detail, so I'm not going to go in detail today. You can watch that video in this course. It shows how many times it would take for the company to pay off its debt if its BITA remains constant and all earnings are used for repayment. So the purpose is to evaluate the financial leverage and repayment capability of the company. It helps determine if a company's debt level is sustainable compared to its BITA, a very, very important ratio. Right. Let's move on. Let's have a look at the formula. We take the total debt. Now, when I say total debt, I mean it's a short term and long term debt, divide by BITA. Okay, so your current liabilities, your non current liabilities, everything comes under the total debt. Now, let's have a look at the formula. Total debt is $1.5 million. IBITA is $500,000. So put in the formula, divide by IBITa, you get three. Now, it's very, very important to understand what does this three mean? It means the company's debt is three times larger than the IBITa. So for every $1 of BTA the company earns, it has $3 in debt. So the debt is extremely larger than the capacity of the company. Now, some people also say this is another opinion. They say that the company would approximately take three years to pay their debt from IBITA. Now, why do they say this? They say this because the BTA, the value is for one year only. So when I divide the debt by the one year amount, the answer I get represents the time. So if I pay my debt through my IBITA, it would take me three years to cover my debt, $500,000 in the first year, $500,000 in the next year, and $500,000 in the third year. Now, this opinion, in my personal opinion, it's not so credible. The reason is we can't assume that the BITA would stay fixed and constant every year. It would fluctuate. It could go up, I could go down as well. So saying this that it takes three years to pay, this is not so credible in my personal opinion. Like, let's move on. Let's interpret the values. If your debt to BITA ratio is less than three, then that's normal. It indicates that the company has a manageable level of debt compared to its earnings, and it suggests strong financial health and a lower risk of default. If the ratio is greater than five, then you should start praying to God that God helps you. It indicates a high level of debt relative to earnings which could increase chances of default. It is a situation of distress, financial distress and a danger zone. Right. Now, this was the debt to IBITA ratio. Now, always, I want you to remember one thing that you can't rely on one ratio alone. You have to see many other ratios. Now, this ratio also has its pros and cons. This does not include capital expenditures, right? And a company with high EBITA, but poor cash flow may still struggle to service its debt. This does not include cash flows only. It's very important when you use the debt to bita ratio, you must compare with the same industries. All right? So that's it for today. I'll see you in the next video. Thank you very watch. 18. The Interest Coverage Ratio: Hi, everyone. Today, we are discussing another key ratio, the interest coverage ratio. Let's get started. So the interest coverage ratio measures a company's ability to meet its interest payment obligations using its operating profits. So basically, the purpose is to evaluate how comfortably a company can handle its debt related interest payments, which is a critical indicator of financial health. Moving on, let's have a look at the formula now. So we take earnings before interest and taxes divided by the interest expense for the year. Now, you might be wondering, why do we take earnings before interest and taxes? Well, it's pretty simple. The entire ratio we are studying right now, interest coverage, we are trying to see, do we have sufficient profit, sufficient earnings to cover our interest obligations. This is why we take the profit before subtracting interest because interest is the main principle over here. Secondly, interest and taxes, they don't represent my core business activity. They're not involved in my core operations. They are fixed obligations. They're not part of my general expenses, so we have to subtract it, meaning, remove it from the formula, add it back to attain the correct value. Right. Now, interest expense for the year. Is our interest obligations for the year. The total expense payable, which includes accrued. For instance, the loan payable is $100,000, and the interest expense is 5% per annum. So if I multiply 5% with $100,000, I have to pay this $500 every year as per the agreement. This is the interest expense for the year. Let's have a look at an example, right? Earnings before interest and taxes is $500,000. The interest expense is $100,000. So we take earnings before interest and tax divided by interest expense. Now it's very, very important. I want you to understand something. In order to remove this $100,000, what should I do? Nothing. I won't do anything because the value I got, that's already before interest and tax. I wrote the interest expense only to confuse you. If I wrote earnings after interest and tax, then I would add back $100,000 in order to make it zero. So we divide this by interest expense for the year. We got five. Now it's very important to interpret what does an interest coverage ratio of five mean. So it means that the company's earnings before interest and tax can cover the annual interest expense five times over. This means that the company generates enough operating profit to comfortably meet its interest payments multiple times in a single year, leaving it with significant profit remaining for other purposes. Okay? Now, this indicates strong financial health. It means the company has enough earnings. They could easily meet the interest obligations. They can even paid five times in a year. They have so much profit. But let's move on and see the interpretation. If you have a higher ratio which is above two or three, this suggests that the company earns significantly more than its interest obligations, and it has a strong financial position. If your ratio is below one, it obviously means you do not have enough earnings before interest to cover your interest obligations. And obviously, you have to go for external funding. And when you borrow external funding, your interest obligations would also increase causing you significant financial distress. And there would be a high probability of default on loans. Right. So, guys, that's it. I'll see you in the next video. Thank you very much. 19. Long Term Debt to Capitalization: Hi, everyone. We are covering a key ratio called the long term debt to capitalization ratio. Let's get started. So the long term debt to capitalization ratio measures the proportion of a company's long term debt relative to its total capitalization, which includes both debt and equity. So long term debt are basically your long term liabilities, your long term obligations that you have to repay after a very long time. And they are used for extremely significant purposes. For instance, if a company intends to buy an expensive non current asset, they tend to expand, they tend to penetrate into a new market. So the finance generated, the liability generated for that purpose is your long term debt. Capitalization refers how a company finances itself. So it provides insights into how much of the company's funding comes from long term borrowing. You all might be wondering, why do we ignore short term debt? And in this entire ratio, why are we focusing on long term debt only? The reason is very similar. So short term debt is temporary, and it's used to address working capital needs, the operating expenses and obligations for day to day purposes. So short term debt is not so significant. On the other hand, short term liabilities, they fluctuate frequently, and they may not provide an accurate picture of the company's long term financial health. Now, long term debt reflects fixed oblig so they will stay on the balance sheet for several years, providing a stable measure of leverage, which is why we focus on long term debt only, and we ignore short term debt. So let's have a look at the formula. We take the long term debt divided by long term debt plus shareholders equity. The numerator represents the debt. The denominator represents the capitalization. Now you might be wondering why am I adding long term debt in the denominator. Again, the reason is that this represents the total financing pool. The denominator reflects the total funds available for the company's operations. You know a company can finance through debt or equity. So both are financing options. So that's the total capitalization. Right, let's have a look at an example. A company has long term debt worth $1 million and shareholders equity worth $2 million. We put in the formula divided by $3 million, $1 million plus $2 million. That's $3 million multiply by 100, so we get 33.33%. Now, very important to understand what is the 33.33%. It means that 33% of the company's total capitalization is financed through long term debt, while the remaining 67% comes from equity. So this indicates a low level of financial leverage and a strong reliance on equity financing. This minimizes financial risk. Now, let's interpret the answers. If your answer is less than 50%, that's a normal safe ratio. It indicates less financial risk. The company relies more on equity than debt. The balance sheet would look stronger due to a higher proportion of equity. Shareholders may see this as positive because the company has less debt burden. On the other hand, if your ratio is greater than 50%, then that shows higher financial risk because the company carries more debt. However, you'll find leverage for growth. If managed well, this reliance on debt can enhance the returns on equity because the company is using borrowed money to fund growth opportunities. This may create potential investor concerns as well. High debt levels might deter investors or lenders if they feel the company's financial position is too risky. So, guys, I'll see you in the next video. Thank you very much. 20. Earnings Per Share: Hi, everyone. Today we are covering a very important valuation ratio, the earnings per share. Let's get started. So what is EPS? Earnings per share is a key financial metric that shows how much profit a company generates for each outstanding share of its common stock or ordinary shares. Now, outstanding share basically means the number of shares that have been issued out of the authorized share capital to the general public. In this case, in EPS, we only deal with the ordinary shareholders. Now, who are the ordinary shareholders, we'll see in the next slide? It's a crucial indicator of a company's profitability, and it's often used by investors to assess a company's financial health and potential for growth. So earnings per share basically shows the potential of the company. When we divide the earnings with the number of shares, we are basically trying to show the investors that what is the potential for each shareholder in this company. Investors would use the EPS to gauge a company's profitability and compare it with competitors in the same industry. The EPS helps assess how well a company is utilizing its resources to generate profits for shareholders, right? Very, very important for growth potential and financial stability. Now, before we move on, it's very important to understand the difference between the ordinary shareholders and the preference shareholders because I told you that the earning per share is only for the ordinary shareholders. Why is that the case? For that, we have to see the difference between both. So the ordinary shares are also known as common stock. In the previous slide, if you so I wrote in the third line, generates for each outstanding share of its common stock. So ordinary shares are also known as common stock, and preference shares also known as preferred stock. So the ordinary shareholders, they're entitled to dividend after the dividends are paid to the preference shareholders. Now, the word preference basically means that the preference shareholders, they have a prior right for dividends. They are entitled to a fixed dividend. If something would be left, then that would be distributed to the ordinary shareholders. Ordinary shareholders have a lower claim on the assets and earnings. On the other hand, the preferentihareholders, they have a higher claim on the assets and earnings. If the company decides to wind up its operations, so the company's priority would be to repay the outstanding capital to the preferentiaholders by disposing of the assets first. If something would be left, then that would be given to the ordinary shareholders. Ordinary shareholders have voting rights and preference shareholders, they do not have voting rights. So preference shareholders, basically, they're given a fixed dividend every year. That's going to be fixed. But the ordinary shareholders, their dividends are variable. Sometimes they would get dividends, sometimes they wouldn't get dividend. They could get a higher dividend or lower dividend based on the voting in the annual general meeting. Now if I show you the formula, we take the profit after interest and tax and subtract preference dividends. The reason why we subtract preference dividends is because we are seeing the earning potential for the ordinary shareholders. The first priority, the first obligation is to pay dividends to the preference shareholders. After that, what's the potential of the company? So in order to find that potential, we have to first get rid of our obligation by paying the preference dividends and what's left would go to the ordinary shareholders. Divided by outstanding ordinary shares. Outstanding ordinary shares are the number of ordinary shares issued to the ordinary shareholders. Now, let's have a look at an example. A company has net income. Net income is your profit after interest and tax worth $1 million, preferred dividends of $100,000 and SAS outstanding of 500,000. Now, let's put this in the formula. The net income is $1 million, subtract the preferred dividends of $100,000 divided by 500,000 ordinary shares, we get 1.8 dollar per share. Now, very important to understand what does this 1.8 mean? It means that the company earned 1.8 $0 of profit for each outstanding share of common stock. So basically, we divided the profit with the number of ordinary shares issued. So this shows the earning potential of the company, what is available for the ordinary shareholders. That's $1.80. So always remember, if we interpret the EPS, a high earning per share suggests that the company is highly profitable and generates substantial income per share. However, if there's a low EPS, that would indicate a lower profitability or higher costs relative to revenue. Probably the expenditures are too high, revenue is too low. Very important when you compare companies, you should see that their style is the same, their way of doing things is the same. If you're comparing a company that has not issued dividends with a company that issued dividends, obviously, the earning per share wouldn't be reliable. See you in the next video. Thank you very much. 21. The Price to Earnings Ratio: Hi, everyone. Today, we are discussing one of the most important ratio in my course, the price to earnings or PE ratio. Let's get started. So the price to earnings ratio is a common use metric to assess the valuation of a company relative to its earnings. It helps investors determine whether a company's stock is overvalued or undervalued compared to its earnings potential. So basically, it represents the amount investors are willing to pay for each dollar of earnings. I prepared a scenario which would help you understand why using the price to earnings ratio is important. So let's assume you decide to buy this beautiful red apple or this beautiful green apple. These are the two options you have. The red apple costs $5, and the green apple costs you $4. Now, obviously, from the naked eye, you would assume that the green apple is cheaper. The green apple would give you more value because obviously it's costing you $1 less. But you know what? That's not the case. The price is a very basic decision. Price gives you very limited information. You have to look at various other factors to decide whether a product is giving you more or less value. So let's assume the weight of both apples are the same. 80 grams. They weigh 80 grams respectively. However, there's some important information, which could be very useful. Let's say the sugar content in the red apple was 10 grams and the sugar content in the green apple was 6 grams, right? Now, this is very useful information. For a moment, just imagine that this sugar content is the earnings of the apple, right? So what if I divide the price with the sugar content? Price of apple divided by the sugar content. So for the red apple, I get 0.5, and for the green apple, I get 0.7. So this basically means I am willing to buy 0.5 dollar for every 1 gram of sugar content in the red apple. The other hand, I'm willing to invest 0.7 dollar for every 1 gram of sugar content in the green apple. So based on this, you can clearly see that the red apple is actually cheaper because I'm willing to invest less for more sugar content or for more earnings. This is exactly what the price to earnings ratio tells us. How much are you willing to invest for every $1 of earnings? If you're investing less for more earnings, obviously, that is going to be cheaper for you. Or, in other words, that's going to give you more value. So let's have a look at the formula. Take the price per share, divided by earnings per share. Now, in the previous video, I discussed earning per share in detail. You can watch that video before watching this video. But for those who did not watch it, we take the net income minus preferentis divided by the number of ordinary shares. So let's look at an example. Let's assume a company has the price per share of $100 and earnings per share of $5. So when you divide both, you get 20. Now, this 20 means that the stock is trading at 20 times its earnings. Me as an investor, I'm willing to pay $20 for every $1 of earnings in the company. All right? Now, let's have a look at a more practical example. Let's say this is Dos limited, and this is MOS limited. So the SHAP price in Dosited is $60, and earnings per share is $3. In Mosited, the share price is $75, and earnings per share is $5. So obviously, a layman would think that Dosited is cheaper because the share price is low. So obviously, investing in Dosimited would be more cheaper for you and it would give you more value. But again, I told you, price is a very basic factor. Price does not give you the entire information you require. So what we can do is we can divide the Sha price and the EPS, so we would get the price earnings ratio. So $60 divided by $3, I got 20. And for MOS limited, $75 divided by $5, I got 15. So now you can clearly see that the price earnings ratio of Msimited is lower than the price earnings ratio. Of DoS limited. Even though the share price is higher, the earnings per share is higher. Now, let's dig more deeper into the price earnings. For Dosimited, the price earnings is 20. This means me as an investor, I am willing to pay $20 for every $1 of earnings in DOS limited. The other hand, in Moss Limited, I'm willing to invest $15 for every $1 of earnings in the company. So if you look at Mosited, it's actually cheaper because I'm investing lesser, isn't it? I'm investing less for more earnings. So investing in Mossimited would be a better choice based on the price earnings ratio, right? Right. Moving on, if you go to yahoo finance.com, there are many, many websites, but I prefer Yahoo Finance because it's a very simple. So you can see this is the price earnings ratio of McDonald's Corporation 25.73. Now, what is TTM trailing 12 months? I'll explain at the end of this video. So 25.73 basically means me as an investor, I'm willing to pay 25.7 $3 for every $1 of earning in McDonald's. Right? Right. Now, let's see the pros and cons of a higher price earnings ratio. You might think that that's expensive, that's bad. No, that's not the case. Both have the pros and cons. So, most importantly, a high PE ratio indicates bullish behavior. A high PE ratio often indicates that investors, they expect strong future growth. They have confidence and optimism about the future prospects of the company. However on the other hand, it could indicate a stock is overvalued and overvalued stocks, they have a lot of expectations on the company. Shareholders, investors, they have a lot of, you know, expectations that the company would grow a lot. So it's very risky. What if the company does not fulfill all those expectations and all the growth prospects don't be fulfilled? That's very common. On the other hand, let's have a look at the pros and cons of a lower price earnings. So a lower price earnings means that the stock is cheaper. For you, it's undervalued. And value investors, they love low PE ratio stocks because they prefer buying stocks at a discounted price, hold the stocks, and when the price goes higher, then they would sell the stocks. However, if you look at the cons of a lower price earnings ratio, a low price earnings ratio might indicate low confidence, bearish behavior. Also, there could be a potential reason why is the price earnings ratio low? There could be problems what you're overlooking financial problems, operational problems, liquidity problems, management issues. There could be some problems. Why is the price earnings ratio low? Finally, there are types of price earnings ratios. First, there is a trailing price earnings ratio. In the picture you saw TTM trailing 12 months. This basically means the price earnings ratio is based on the company's past 12 months earnings. There's a forward price earnings, that's based on the estimated future earnings. There's Schiller price earnings, that's based on the average inflation adjusted earnings over the past ten years. See you all in the next video. Thank you very much. 22. The Price to Sales Ratio: Hi, everyone. Today, we're discussing the price to sales ratio, PS ratio. This is extremely similar to the price to earnings ratio. Let's get started. The PS ratio measures how much investors are willing to pay for each dollar of a company's revenue. This is also a valuation ratio, exactly like the price to earnings ratio. In the PE ratio, we compare price with the earnings. In this, we compare price with sales. The formula is very simple, market price per share, divided by revenue per share. Now, what is revenue per share? You take your total revenue divided by the number of outstanding shares. Outstanding shares means the number of shares issued to the public. Now, for example, total revenue is worth $500 million. Total outstanding shares are 50 million, and the market price per share is $50. So we'll take the market price per share, divided by revenue per share. Market price per share is already given. In order to calculate the revenue per share, we'll take the total revenue, which is $500 million, divided by the total outstanding shares, which is 50 million, so we'll get $10 per share. Now, we'll divide both and we'll get five. Five basically means that investors are willing to pay $5 for every $1 of revenue the company generates. Now, as I told you, this is exactly like the price to earnings ratio. A lower ratio would suggest that the company is undervalued, a higher ratio would suggest that the price is overvalued, but the interpretation would be slightly different. So let's have a look at the pros and cons of a higher PS ratio. Right? The first reason is the pro of a higher PS ratio, it indicates strong growth potential. So basically, a high PS ratio often suggests that investors anticipate significant revenue growth in the future. That's a very good thing. Secondly, market confidence. This could reflect strong investor confidence in the company's future prospects. And obviously, factors like a strong brand, competitive advantage or favorable industry outlook could support this. Then higher margins are expected. A high PS ratio can indicate that investors expect the company to generate high profit margins in the future. Now let's have a look at the cons of a higher PS ratio. Obviously, there's a risk of overvaluation, and if the company fails to meet the high expectations of investors, its stock price could decline significantly. Secondly, this entire ratio ignores profitability. This is the price to sales ratio, and a company with a high PS ratio may not be profitable, or its profits may be low relative to its revenue. Lastly, market volatility. So companies with high PS ratios are often more susceptible to market volatility. It's because the stock prices are more likely to be driven by investor sentiments, and that could fluctuate. Right? Now, let's have a look at the pros and cons of a lower PS ratio. So first, it indicates undervaluation. A lower PS ratio might suggest that the market is underestimating the company's true value. Now obviously, this could be cheaper for investors who want to buy stocks at a discount. Secondly, it could be a safer investment because companies with lower PS ratios, they often have established revenue streams. Thirdly, focuses on revenue stability. So a lower PS ratio indicates that investors are more focused on the company's revenue stability rather than its profitability. No, this can be beneficial for companies and industries with high growth potentials. Then let's have a look at the cons of a lower PS ratio. When a stock is undervalued, it could signal that the market expects low future growth for the company. It could be due to various factors such as increased competition, changing demand, et cetera. Then possibly poor profitability, a lower PS ratio might indicate that the company has low profitability margins, and it could be a concern. And obviously, a lower PS ratio can make a company's stock price more susceptible to market fluctuations. Right. Now, let's have a look at the comparison of the PS ratio and the PE ratio. So the PS ratio focuses on revenue, totally on revenue, and the PE ratio focuses on profit. The PS ratio can be used for companies with losses. However, for the PE ratio, that requires positive net income. Thirdly, the PS ratio is less affected by profitability margins because profit is not taken into consideration, but PE ratio is extremely sensitive. A, a minor change in profit could result in a major change in the PE ratio. Lastly, the PS ratio ignores costs and profit margins. However, the PE ratio can be distorted by accounting choices. Like there are certain one off expenses such as the cost of restructuring, the cost of impairments. Taxation policies. Now, those one off expenses, they could significantly distort your PE ratio because they affect the profitability. That's it for today. See you guys in the next class. Thank you very much. 23. The Price to Book Ratio: Hi, everyone. Today we are discussing another key ratio, the price to book ratio. We saw the price to earnings ratio. We saw the price to sales ratio. Today we are seeing the price to book ratio. These are old valuation ratios. They help in the valuation of the stock or the company. Right. What is the PB ratio? The price to book ratio is a financial metric that compares the stock price to its book value. Book value means the net asset value. What is the net assets, your assets minus liabilities? Again, this helps investors evaluate whether stock is undervalued or overvalued, and it's particularly useful for companies with significant tangible assets, such as banks, real estate, and manufacturing firms. So the PB ratio basically gives investors an idea of how much they're paying for each dollar of a company's net assets. For example, let's see the formula. We take the market price per share divided by the book value per share. Now, book value per share means the total net assets divided by the number of outstanding shares. Outstanding shares are the shares issued, and net assets are assets minus liabilities. Let's look at an example. For company ABC, the market price per share is 25. The book value per share, sorry, market price per share is 50, and book value per share is $25. So we'll take the market price per share, divided by book value per share. $50 divided by $25, we got five now, what does this five mean? It means that investors are willing to pay $5 for every $1 of net assets the company owns. Okay? Again, I'm telling you, again, again, this is the valuation ratio. So obviously, the lower it is, it means it's cheaper. The higher it is, it's going to be expensive, but we have to look at the context as well. Both low and high always have the pros and cons. Now, let's have a look at the pros and cons of the PB ratio. So the PB ratio is very simple and easy to calculate and understand. It's useful for evaluating companies with significant sorry, significant physical assets, such as real estate, machinery. It's also helpful in identifying undervalued or overvalued stocks. One problem is that it doesn't account for intangibles. Now, intangible assets are very important, such as the brand name of the company, patents, copyrights, they're all intangibles. So the PB ratio totally disregards them. We only look at tangible assets, not intangible assets. Secondly, it's limited and it's only relevant for certain companies such as technology or manufacturing firms with heavy machinery. Lastly, it's not a profitability measure. It doesn't directly measure profitability, doesn't measure revenue. It only accounts for the net assets. So, guys, essentially, the PB ratio gives a snapshot of a company's asset value relative to its market price. But remember, it has limitations as well, especially for companies with strong intangible assets. See you on the next video. Thank you very much. 24. The Price to Cash Flow Ratio: Hi, everyone. Today we are discussing the price to cash flow ratio. We saw the price to earnings ratio, the price to book ratio, the price to sales ratio. Today we'll see the price to cash flow ratio. Let's begin. Now, what is the price to cash flow ratio? The price to cash flow ratio is a valuation metric that measures the market's valuation of a company's operating cash flow. Now, we focus on the operating cash flow. Operating cash flow refers to the cash flow generated from the core operating activities. If I run a school, then the cash flow earned from the school fees would be the operating cash flow. If I run a furniture business, then the proceeds I receive from the selling of the furniture, that would be my operating cash flow. So we don't consider other cash flows, such as investing cash flows. If I made investments, then the returns I generate, no. We only focus on the operating cash flow. Now, this is ideal for industries with high cash flow generation, such as energy companies, utilities companies or retail companies. And if a company's earnings are highly volatile due to non cash items. So for instance, if there's a company that produces heavy machinery like Boeing and ABS. So obviously, their aircraft would be subject to severe depreciation. So in order to find a credible estimate, it's better to use the price to cash flow ratio because we remove all non cash items such as depreciation, we add them back. Right. Now, let's see the formula. We take the market price per share, divided by the operating cash flow per share. So it's divided by the number of outstanding shares. So I told you this operating cash flow represents cash generated from co operations. So we divide that with the number of outstanding shares. For example, company XYZ, the market price per share is $50 and the operating cash flow per share is $5, so we divide them $50 divided by $5, we get ten. Now, what does this mean? If I invest $10 in the company, I'm willing to pay $10 for every $1 of cash the company owns, operating cash flow. Now, let's have a look at the pros and cons of the price to cash flow ratio. So first, it's less susceptible to manipulation, like this does not consider profit. It only considers cash flow. So if I recognize incoming revenue, revenue earned in the future, if I recognize that now that's sort of a manipulation. But in the price to cash flow, we only focus on cash. It's useful for companies with high non cash expenses and avoids impact of nonrecurring expenses. These nonrecurring expenses are one off expenses, for example, restructuring costs, impairments, taxation, gain or losses on disposal. These are all nonrecurring, so it avoids the impact of all those expenses. However, if we look at some cons of the price to cash flow ratio, it totally disregards profitability. Even revenue. This only focuses on cash flow. It does not account for debt. Now, debt is a crucial element that's also known as cash flow from financing activities. So in this ratio, we only focus on the operating cash flow. So one problem is that it does not account for the interest payments that are going. Those are also cash outflows, but it totally disregards them. Also, it's not ideal for companies with a low cash flow or negative cash flow. So for them, they would have to use another ratio, probably the price to earnings ratio. So see you next video. Thank you very much. 25. The Price to Growth Ratio: Hi, everyone. Today we are starting the price earnings to growth ratio, the PEG ratio. So let's get started. What is PEG ratio? The PEG ratio is a valuation metric that adjusts the price to earnings ratio for the growth rate of a company's earnings. It aims to provide a more complete picture of a company's valuation by factoring in its expected earnings growth rate rather than just focusing. Hi, everyone. Today we are starting the price earnings to growth ratio, the PEG ratio. Let's get started. What is PEG ratio? The PEG ratio is a valuation metric that adjusts the price to earnings ratio for the growth rate of a company's earnings. It aims to provide a more complete picture of a company's valuation by factoring in its expected earnings growth rate rather than focusing on its current earnings. So whatever ratios we studied up to now, the price earnings ratio, the price to sales ratio, the price to book ratio, the price to cash flow ratio, they all focus on the present data. This ratio focuses on your expected earnings, on your expected forecasting. So this is pretty useful for investors. Let's have a look at the formula. We take the price earnings ratio divided by the earnings growth rate. The earnings growth rate is basically the expected annual growth rate in earnings, typically over the next five years. This is expressed in a percentage. So for example, you can see company X. The current share price is $50. The earnings per share is $2.5, and the expected earnings growth rate is 20% per year. So let's apply this in the formula. The PE ratio is 20. The earnings growth rate is 20. We ignore the percentage. Now our answer is one. Now this is a pretty good estimate one. Let's have a look at the interpretation. So if the PEG is exactly one, this suggests that the stock is fairly valued. It suggests that the stock Nah, if your PEG is exactly one, this suggests that the stock is fairly valued relative to its expected earnings growth rate. So for example, if a company has a PE ratio of 20 and is expected to grow its earnings by 20%, the PEG would exactly be one. In this case, the stock's price seems to reflect its expected growth potential. If your PEG is less than one, that's undervalued. This could indicate a buying opportunity if the company is expected to grow at a strong pace. For example, if a company has a PE ratio of 15, but is expected to grow earnings by 20% annually, so the PEG ratio would be 0.75. This suggests that the stock's price may be lower than what its projected growth justifies, making it a potentially attractive investment opportunity. And if the PEG is more than one, the stock price might be too high compared to the company's future growth prospects. So for instance, if the PE ratio is 30 and is expected to grow earnings by 20%, the PEG ratio would be 1.5. Now, this indicates that investors might be paying a premium for the company's expected growth, and the stock price may be higher than its actual growth potential warrants. So this was the interpretation of the PEG ratio. Uh, PEG ratio helps investors consider a company's growth prospects alongside its current valuation. However, always remember one thing, guys, it's important to note that the PEG ratio relies on estimates of future earnings growth. Now obviously, everyone would present a misleading, a beautiful picture. They would embellish their forecasting, which can be uncertain. I hope this explanation is helpful. See you in the next video. Thank you very much. 26. Market Capitalization: One. Today we are discussing market cap, also known as market capitalization. Let's begin. Market capitalization refers to the total value of all outstanding shares of a company's stock, which is a reflection of the company's size, financial health, and investor sentiment. Now, I told you this many times that outstanding shares of a company basically means the number of shares issued to the general public. So it is a commonly used metric to categorize companies and assess their market value. Now, obviously, the more stocks or more shares a company issues, the more capital they generate, which is also known as share capital, the higher share capital a company has, it reflects the strength, size, and financial health of the company. Now let's have a look at the formula. We take the share price and multiply with the total number of outstanding shares. So share price multiplied by the total number of shares issued. So having a look at an example, company ABC, the share price is $100. They issued 1 million shares, so we multiply $100 with 1 million, we get $100 million. This is their market cap or their market capitalization. Let's interpret the market cap. So a small market cap could be around $300 million to $2 billion. A medium cap would be $2-10 billion, and a large cap would be above $10 billion. And any market cap below $300 million, that's known as micro cap. So this is the different interpretation. Now, let's have a look at the importance of market cap. First, company size and stability. So market cap directly reflects a company size. Always remember that. Larger the market cap, that indicates a bigger company with more resources and a stronger financial position. Obviously, it would have stability as well. Risk assessment. So market cap can basically help assess investment risk. Higher market cap companies are often considered less risky due to their established position and financial strength. Investment Strategy. So basically, there are two type of investors, growth investors and value investors. So investors may use market cap to categorize companies as growth, meaning they have a high market cap. They have a potential for future growth or value, low market cap undervalued assets. Then mergers and acquisitions. So basically, market cap plays a role in merges and acquisitions. Companies with high market caps may be attractive acquisition targets for larger companies. So, guys, that's it. I'll see you in the next video. Thank you very much. 27. Enterprise Value: One. Today we are discussing enterprise value, also known as EV. So let's have a look what is all this about. So enterprise value basically represents the total value of the company you're buying. It represents the theoretical takeover price that an acquirer would pay. So it accounts for a company's debt, cash, and other financial obligations, providing a clearer picture of its financial standing. Let's have a look at the formula. So in order to calculate the enterprise value, we take the market capitalization. We add the total debt, and we subtract cash and cash equivalents. So this would be the entire value of the company, the price I'll pay to buy the company. Now, let's look at two things. First thing, market capitalization, we covered that. Total debt, you know, what's total debt. So basically, this refers to the entire capital structure of the company. Whenever a company raises capital, it could be either through equity, which represents the market capitalization, or it could be through debt finance, which which represents the total debt. So, number two, why do we subtract cash and cash equivalents? Why? You might be wondering why subtract cash and cash equivalents? What's the logic? Now, I'll explain with a scenario made by myself. Now, let's assume that you intend to buy a house, all right? You intend to buy this house which is worth $100,000. Fine. Now, when you buy the house, you are buying all the belongings in the house, right? Whatever is in the house, that will be yours. However, what if when I was buying the house, the owner told me that there's a safe, a secret safe, which has $10,000 cash. What do you think I should do now? Should I just take that cash? Is that included in the price I buy the house or should I subtract this $10,000 from $100,000 and pay $90,000 to the owner and take possession of the house? What should I do? I would do the second thing. Okay? So what I would do is I would subtract this $10,000, use it as a discount in the price. I would end up paying $90,000. So basically subtracting cash from the enterprise value is like taking away the extra money in your pocket before figuring out the true value of a house you want to buy. It helps us focus on the value of the house itself and not get confused by the extra cash. The reason why we subtract the cash is if I don't subtract the cash, I would add the cash, right? I could either add something or subtract something. If I add the cash, it means the value of the house would be 110,000. But that's baseless, right? Because there's cash present there, which belongs to the previous owner, so it's my right to subtract that in the value of the house so I could use the cash. This is why we subtract cash in the enterprise value formula. Let's have a look at an example. If a company has a market capitalization of $1 billion, 500 million in total debt, and 100 million in cash. So what we would do is very simple. We take $1 billion. We would add the debt of 500 million and subtract the cash of 100 million. So we'll be left with $1.4 billion. So $1.4 billion is the cost to acquire the entire company. This is enterprise value. See you in the next video. Thank you very much. 28. Enterprise Value to Sales Ratio: Hi, everyone. Today we are starting the enterprise value to sales ratio, EV to sales ratio. So let's degrade. So the EV to sales ratio is a key valuation metric that helps investors understand how much it would cost to acquire a company relative to its revenue. It shows how many times a company's annual revenue you'd be paying to acquire it. So for example, an EV to sales ratio of three means you'd be paying three times the company's annual revenue to buy it. So this ratio is particularly useful for valuing companies, companies which have no or very low profit margins, for example, startups or high growth companies or those companies in the early stages of development and may not be profitable yet. This helps investors determine the value of a company based on its revenue, especially when profitability is not a significant factor. Let's have a look at the formula. So we take the enterprise value. We covered this in the previous video, divided by sales. That's it. So let's assume a company has the following financial details, market cap, $100 million, total debt, $200 million, cash, $50 million, and the total revenue is $100 million. So in order to calculate the enterprise value, we take the market cap, add the total debt, subtract cash. So that would give you the enterprise value, $650 million. This is your enterprise value. Now, divide this with sales. So 650000000/100000000, you get 6.56 0.5 X, 6.5 times, whatever you want to call it. This means that the company's enterprise value is 6.5 times its annual revenue, right? So that's how you calculate the EV to sales ratio. See you all the next video. Thank you very much. 29. Enterprise Value to EBIDTA Ratio: Hi, everyone. Today we'll be discussing the enterprise value to Abita EV to bita ratio. So let's dig right in. EVE to EBITA ratio is a key evaluation metric that helps investors understand how much it would cost to acquire a company relative to its EBITA. It shows how many times a company's EBITA you'd be paying to acquire it. So in the previous video, we discussed EV to sales ratio. So the EVI to sales ratio basically shows how many times a company's sales you'd be paying to acquire it. So in this, we focus on IBITa. Now, I made a video in detail. Please go watch what is IBTa because I'm not going to explain it today. So let's have a look at the formula very simple. We take enterprise value divided by IBITa. So question is, let's assume a company has the following financial details, market cap worth $500 million, total debt worth $200 million, cash $50 million, and EBITA, $50 million. So let's calculate enterprise value first. Go watch my enterprise value video if you're still having problems. So we take the market cap, add the total debt subtract cash. We get 650 million. So 650 million divided by IBITA 650000000/50000000, we get 13. So this means that the company's enterprise value is 13 times its IBITA. This is a market valuation ratio. So, guys, that's it for today. Thank you very much. Have a good day. 30. Demystifying the Statement of Profit & Loss - Basic Version: You have to understand the difference between cost of sales and expenses. Cost and expenses are two different components. They are as different as day and night, so do not mix them. Okay? I would give you an example of KFC. In both cases, for cost of sales and expenses, we would talk about KFC. Now I'm going to ask you one question. What is KFC's main product? Their main product is fried chicken. So if I ask you what could be the cost of their main product? They could be the cost of chicken, the most important component of the product, cost of potatoes. Who likes KFC without french fries? No one, right? Cost of buns. For the burgers, very, very important. Cost of flour and the seasoning for the chicken mix. These are all very, very important and the cost of drinks. Okay? So these items are needed to prepare the inventory, to prepare the co product of KFC. So, guys, cost of sales are the direct costs involved in acquiring the inventory to be resold. In cost of sale, we only focus on one component, and that's inventory, the direct costs. If I talk about expenses, expenses are the overall costs of running the business. They are not limited to inventory. If I talk about KFC, they could be the rent bill, salaries, electricity, gas. These are all the overall bills a business pays. This is not related with inventory, okay? They are all indirect. I hope you understand the difference between cost of sales and expenses. Moving on, you have to understand the difference between carriage inwards and carriage outwards. This is also very important. So, guys, let me give you an example of carriage inwards. Let's say the business location of XYZ Limited is in Sydney and their supplier is in London. So this is a very, very important point. Look at the distance between London and Sydney. It's one of the longest flights in the world today. 20 hours and 30 minutes. Imagine the cost involved. So if the business imports inventory from London, it's going to be massive. The cost would be extremely high. So this is called carriage inwards, okay? The cost of transporting goods to the business location. Now, this is part of the cost of sale because this is a direct cost related to inventory. Okay? So this is added in the cost of sales. On the other hand, carriage outwards is something different. It's the cost of delivering goods to the customers. It's like the delivery charges. When you order something from Amazon or from Ebay or Shopify, sometimes you won't pay delivery charges. That's borne by the business alone. So that's carriage outwards. Now, carriage outwards is not your cost of sale. It's your expense because this is not related with inventory. After the goods have been acquired from London, after the products have been imported from London, when it's time to deliver the product to the customer, there is carriage outwards. So this is an expense. It's not related. It's not adding or increasing the cost of your inventory. So remember the main difference is carriage inwards is part of the cost of sale and carriage outwards is an expense. Alright? Let's move on. Let's look at the difference between gross profit and net profit. Now that you understand sales, you understand cost of sales expenses, so this would be easy for you all to understand. So, guys, gross profit and net profit, gross profit is the profit a business makes after deducting the direct cost of sales from revenue. Okay? You only subtract your cost of sales from the revenue. It shows how profitable the core business activity is and how demanding is the product, how well the business controls its costs. This is gross profit. The formula is revenue minus cost of sales. So what is net profit? The word net means after all deductions. The word gross means before any deductions. So net profit is the final profit after deducting all expenses, including cost of sales from the revenue. This reflects the overall profitability, the overall picture of the business. So the formula is gross profit minus expenses. All right? Right. Moving on. We have to understand the movement of inventory. This is very, very important. We have to understand the movement of inventory and cost of sales. So, guys, the first thing a business uses. The first part of cost of sale is called opening inventory. Okay? Now, this is the value of the goods the business has on hand at the beginning of the period. It's the leftover from the previous period. The first priority of the business would be to sell your opening inventory. Consume this inventory. Otherwise, it could get worn out or it could get expired. Okay, for example, a bakery starts the year with 100 bags of flour. They already had 100 bags in the warehouse. This is the inventory left from the previous period, okay? So this is the first portion of cost of sales. After opening inventory, there's purchases, you will buy more inventory. Okay? Example, the business buys 500 more bags of flour, and the total cost of this was $2,500, okay? After purchases, you would return some purchases. Obviously, when you're ordering 500 bags, it's possible at least one 2% of those items could be faulty. There could be some defects in those items. So the bakery returns 50 bags of flour worth $250. And obviously importing all the products. Now, not necessarily from another country. It could be from another city or another town in your city. That still comes at a cost. So carriage inwards is a very important cost. It's added to the purchases to the cost of sales. It's the cost of shipping or transporting the goods. So it costs $100 to have the 500 bags of flour delivered, okay? This is also added to the cost of sale a very, very important component. Guys, do you honestly think a business had opening inventory. They had 100 bags. They bought 500 more bags. Now they have 600 bags. They returned 50. They have 550 bags. Do you honestly think a business can sell all of its inventory? That is likely, but that's not so likely. This is possible, but it's very difficult, especially for a new business. A business cannot sell all of its inventory. They would be leftovers, okay? So those leftovers are called closing inventory. Closing inventory represents the value of goods that are unsold, okay? So like, for example, at the end of the year, you have 200 bags of flour left. Worth $1,000. So this would be subtracted from the cost of sale. The reason is what does cost of sale mean? The cost of the items you are selling. So closing inventory is unsold. So why would I add this cost? I would subtract this. Secondly, the unsold items would be transferred to the next period. If they're not sold today, they would be sold tomorrow. So the closing inventory wouldn't be added in the cost of sale. It would become the opening inventory of the next period, and it would be sold in the next period, okay? Right. Now, based on this, let's prepare the formula for cost of sales. Right. We start with our opening inventory, as I explained earlier, which was $500. We add purchases, we subtract purchases returns. We add carriage inwards, we subtract closing inventory, and the answer we get, this is our direct costs or cost of sales. Okay? Now, we only subtract returns and closing inventory. We subtract returns because this is not a cost. We are returning the product to the supplier. So why is this included in purchases? If I return some products, I have to subtract or adjust the cost. And closing inventory, the unsold products, they wouldn't ever be part of the cost of sale. As I said, they would be transferred to the next period. So closing inventory of this period would be the opening inventory of the next period, okay? Right. I'm slowly slowly building a picture of the two statements we prepare, statement of profit and loss and statement of financial position. So let's see what is the statement of profit and loss. So previously, this was known as income statement, and I would refer this as income statement. Whenever I teach you, I'm sure you heard income statement from my mouth many times, especially when we were preparing the ledges, T accounts. So it's okay. This is shorter and easier to understand. But in your exam, you would always call it statement of profit and loss, right? So this statement summarizes all the incomes and expenses of a business. It shows how profitable are you. The main purpose is to calculate the profit. How much profit are you generating from your core activities? So remember, statement of profit and loss is made for one year only. I won't include the previous year's expenses in this income statement. I won't include the next year's expenses in this income statement. We only focus on one year only, right? Okay, so this is how the statement of profit and loss looks like. We take our sales, subtract our sale returns. We get this value. It's called the net sales. We subtract cost of sales, what I just toad you. So when I subtract the sales and cost of sales, we get the gross profit. We add our other income. If you go to my very first videos on important definitions, I told you there are two type of incomes, your main income and your secondary source of income. L a school. Their main source of revenue would be the school fees. But if there's a canteen, giving them rent, if they sold some extra furniture, they earned income. So these are all the secondary sources, the side hustles. So we add that separately, which we call other income. We subtract all our expenses, then we get our ultimate profit for the year. How much profit we made in the year. This is called your net profit. This is your first statement. 31. Demystifying the Statement of Profit & Loss - Advanced Version: Hello, my genius accountants. Welcome to the next video. Today, we would be discussing advanced financial statements and in specific, the advanced version of the statement of profit and loss, a practical and a realistic example. So the website, you can see, is known as yahoo finance.com. And in yahoo finance.com, you would find the financials of all companies that are registered in NASDAQ in the American stock market. There's a company with the name Micro Algo Incorporation, this is a Chinese company which is registered in NASDAQ. So let's have a look at the statement of profit and loss. My aim for today is that I want to break down each term in as simple and easy language as possible in the most easy way. So everyone, regardless of the background you're from, you would understand the financial statement of a company easily and swiftly. Let's begin right away. So first thing that you might find peculiar is something known as TTM. So TTM basically stands for trailing 12 months. Now, trailing 12 months means the most recent 12 months of a company's financial data. Now, not necessarily a calendar of fiscal year, but the last 12 months counting backward from today. So if in simple terms, I give you an example, if you open your bank statement from the website of your bank, would be an option in which you could choose the recent 12 months beginning from today. So as you can see, today is 22 April. So 12 months would go somewhere around tentative 22 April 2024. So that's the trailing 12 months data. It's the most recent data. It gives you the most up to date view of a company's performance. Let's begin. So the formula or the pattern of the statement of profit and loss is the same. First is the total revenue that's given. After the total revenue, you would subtract the cost of revenue. You would get the gross profit. You would subtract the operating expenses. You would add any other income if you have. Then you would get your operating income or operating profit. Now, operating income signifies the profit from the core operations of a company. After operating income, you would see other expenses. But before other expenses, there's something mentioned here, net non operating interest income or expense. So these are basically the interest obligations of a company, like if a company borrows a loan, so the interest they have to repay, that's an expense. That would be subtracted. And if the company lent a loan to another party, they would receive interest. That's income, that would be added. Now, why is this over here? Why is this not part of the operating expense? Reason is very simple, that these interest obligations, they are not operating expenses. They do not signify expenses from your core business operations. These are simply other obligations, so it would be better to treat them separately. Let's move on. Right. After this, you can see the other income. So other incomes would be added, other expenses would be subtracted. Then whatever income you get, that's known as pre tax income. Pre tax income is also known as the income before deduction of tax. So it's the income in which you've deducted your interest obligations. But tax has not yet been deducted, right? Then after this, you have your tax provision. So tax provision is basically the estimated taxes the company needs to pay. And after this, you would get the net income, right? So net income, basically, that's the operating income. But you can see something peculiar. The net income is also known as net income for common stockholders. Now, I want to explain this. In simple terms, it tells you how much profit is available to common shareholders. Common shareholders are the people who hold ordinary shares in a company. Okay. It's the final profit that belongs to the owners of common stock. After all costs, taxes, obligations, preference dividends have been deducted. So in a company, there are two type of stockholders. They're the common stockholders, also known as ordinary stockholders, and then they're the preferred stockholders. So the common stockholders are also known as the owners of a company. Right. Then you get your net income. Right. Now let's move on. Right? After net income, what do you see? After net income, we have the earning per share. Now, I explain earnings per share in detail. Basically how much profit is allocated to each share of stock. Then after earnings per share, you would see the total operating income as reported. Now, this may include all operating activities that are adjusted for any specific accounting treatments, and it's often the official figure shared in financial statements. So if I give you an example, let's say the operating income for company was $9,000. But after the profit was reported, there were some additional adjustments that were required, like probably stock based compensations. Now, the total operating income and the total operating income as reported would slightly differ. So that would be adjusted over a year. After this, the total expenses. So total expenses over here. In this section, it basically means the cost of revenue plus operating expenses, plus interest, plus taxes, and plus other expenses. So basically, all these outflows, if you add all of them, you would find them in the total expenses. Now after this, you would see something which say net income from continuing and discontinued operations. Now, these are technical accounting terms, but I'll try to simplify it in easy language. So basically, this includes earnings from ongoing operations and any business units that were sold or shut down. If I give you a very simple example, let's say, a company sold its bakery division, but it still runs a coffee shop. So now, profits from both would be shown over here. What is still ongoing and the bakery that was shut down, that would be over here. Then after this, we have the normalized income. So normalized income basically refers to income that's adjusted to remove unusual one time events so that you can better assess ongoing performance. Now, every company, they could earn income from ray sources, from unusual sources. For example, if a company sells one of its asset, if a company sells its building or its machine, these are not ongoing operations. These are very rare that could happen once a while. So that would be reflected over here. So if I give you a small example, let's say your net income was $10,000, but there was a gain on disposal of $2,000. So the gain on disposal is a one time gain, right? So that would be subtracted from the net income, and then the remaining balance would be reflected over her. Then there's interest income, this is showed separately, right? It's showed separately, and then the interest expenses in the net, the net of both would be shown separately here as well. Then there would be some ratios earning before interest and tax, then EBITA would be mentioned here as well. Now, we covered all this in detail. Now, after IBITa you would find reconciled cost of revenue. So this is basically an adjusted figure of cost of revenue that may include standardized changes or breakdowns for easier comparison over time. So again, transactions such as any changes for stock based compensations or any other accounting treatments, they would be mentioned over here. Then there's reconciled depreciation. So Again, if depreciation had been adjusted for reporting purposes, you know, depreciation in tax and depreciation accounting, both are calculated separately. So the reconciled values would be mentioned over here. Then there's net income from continuing operation, net of minority interest. Now, this may sound a bit confusing, but it's actually very straightforward. Net income from ongoing business excludes the portion owned by minority shareholders in a company. So majority shareholders are shareholders that have a significant stake in the company. So example, if a company owns 80% of a subsidiary or branch that earned $1,000, so $800 would be yours. The $200 would belong to minority owners. So that would be adjusted or reflected over here. Then there are other unusual items excluding goodwill. So one time gains or losses, except Goodwill. The exception is goodwill Goodwill is not recorded over here. The reason is Goodwill is an intangible asset. It would not be reflected in the statement of provident loss. Then after this, we have a total of the unusual items. So these are, again, all the one time ray items that affect profits. All that would be mentioned over here. It could be impayment or any, legal losses that were incurred. Then there's normalized IBITa so normalized ibta is when you adjust your ibta to remove all the one time or unusual items for better comparison across companies. Then there's tax rate for calculations. So this is basically the tax rate used to estimate tax effects in other calculations, like normalized income. So, for example, if the normalized income is $100,000 and the tax rate is 25%, so the tax impact would be 25% times 100,000, which is $25,000. And then finally, there's tax effect of unusual items. So this is basically the estimated taxes linked to all the unusual items that we've discussed. So for example, if a company has a one time loss of $4,000. So what do I mean by one time loss? Like a loss that happens very rarely, not so frequent, like, if a company sells its building at a loss. So let's say it sold it for a loss of $4,000. So it would reduce the taxes by $1,000, then the tax effect of unusual items would be recorded as $1,000. So these were This was an entire explanation of all the terms mentioned in this statement of profit and loss. The reason why I explained all this in easy terms is so that you can go to Yahoo Finance today, study the financial statements of a company, right? And all these have a link to ratios. Like we have total revenue. We have gross profit. So we can calculate the gross profit margin. We have cost of revenue and gross profit. So we can calculate the cost margin. We have operating expense and operating income. We can calculate the expense to income ratio. And apart from this, we have the earnings per share. We have interest income, interest expenses, depreciation, IBITA. So the statement of profit and loss would be very helpful in calculating ratios. We'll see all that in the next video. So I hope after this video, you will be confident in accessing financial statements of any company and make useful decisions. Thank you very much. See you in the next video. 32. Demystifying the Statement of Financial Position - Basic Version: The second statement is called the statement of financial position. Now, this was previously known as the balance sheet, and this is what I would call it. Whenever I teach you guys, it's easier. I mean, how can I write statement of financial position so many times? So we would refer to it as balance sheet. In your exam, you'll always refer it as statement of financial position. So this provides a snapshot of a company's financial position at a specific point in time. If I'm talking about 20:10, up till 2010, how many non current assets do they have? How many liabilities do they own? So it provides a snapshot of the financial position at a specific point in time. It shows what the company owns, assets, what it owes, liabilities, and equity. It shows these three items. Now, do you guys remember once upon a time, I taught you something called the accounting equation, and I told you the accounting equation applies in the balance sheet. The entire balance sheet is made in line with the accounting equation. That same formula, assets is equal to equity plus liabilities. That same concept, I taught you that it's an equation. It must balance the assets amount must be same with the equity plus liabilities amount. So that same concept applies here as well. Now, let's have a look at the balance sheet. This is the balance sheet. We take the total of assets, total assets, equity. I taught you the formula of equity capital plus profit minus drawings and liability. So this value of total assets must be the same with total equity and liabilities. And by the way, this net profit comes from the income statement. This is why both statements are in line with each other. They are dependent on each other, okay? It must balance. If it doesn't balance, there's a problem in you, not the question. Remember that? 33. Demystifying the Statement of Financial Position - Advanced Version: Hi, everyone, Welcome to the next video. In this video, we would break down the complicated or advanced version of statement of financial position. Let's get started. Now again, we are interpreting the same company we did in the previous lesson in which we demystified the statement of financial position. So today, we would crack the code in the statement of financial position. Let's get started. Now, the first term you can see is total assets. So this includes all assets of a company. It could be current assets, non current assets, tangible assets, intangible assets. These are all the assets. Then the next term says, total liabilities, net minority interest. So this basically means all the money the company owes to others. Plus the share of subsidiaries owned by outside investors. So imagine you owe the bank for a car loan and someone else owns a piece of your business, right? Then after this, there's total equity, gross minority interest. So this basically means the value left for the owners, the shareholders, the stockholders after liabilities are subtracted from assets. And this includes both the company's equity and minority interests. Oh. This is basically what you own after paying off everything you owe. Then after this, there's total capitalization. Now, this is simple. This basically means the total money the company has raised from debt and equity to finance its operations. So, this would be the total debt plus total equity. Let's look at the other terms. Then there's common stock equity. So basically, this is the value of shares owned by the common shareholders or the ordinary shareholders. This is part of equity, and this does not include the preferred stock or the preferred shares. So if I give you an example, let's say 1 million shares were issued at $10 each to the ordinary or the common stockholders. So $10 million would be the common stock equity. Then we can see capital lease obligations. So these are basically the long term lease agreements which are treated like debt because obviously the company's essentially buying the asset, right? So if I give you a small example, let's say a company leases a machine for five years. Records the machine as an asset and the lease payments as a liability. And as the time passes by and as it realizes the lease payments, then that would be transferred out from the liabilities. Then we have the net tangible assets. These are basically all assets minus liabilities, but, of course, excluding intangible stuff, like goodwill, patents, brand value, et cetera. Then there's working capital, a very easy term. Working capital is basically how much short term cash or liquid assets the company has to run their daily operations. So basically current assets minus current liabilities, we covered this in detail. Then there's invested capital. So invested capital basically is the total money invested in the company by both the shareholders and lenders. So this is basically the money working in the business to generate returns. Then there's tangible book value tangible book value basically shows the real physical value of the company. It's the net value of the company, excluding intangible assets like goodwill or trademarks. Then total debt, very straightforward, all the borrowed money, both short term and long term obligations. Then we have the shares issued. Now, these are the value of the shares issued, right? The value. And then we have the number of ordinary shares issued, right? Right. So this was a walk through breakdown of the terms of the statement of financial position. I hope after this video, you would be more confident in assessing the financial statements of companies. And you can always use this video as a guideline. So if you're assessing the statement of financial position of a company or you probably want to make investment decisions or any other decisions, then you can always use this video as a reference. So see you in the next video. Thank you very much.