Profit Margin Ratio in 9 minutes - How to Calculate Financial Ratio Analysis Tutorial

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Profit Margin (Ratio) in 9 minutes - Financial Ratio Analysis Tutorial
http://www.youtube.com/watch?v=auLmI7...

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Profit Margin Ratio
Hi! Before this video you should already understand
the words and concepts found in Financial
Statements. Now, when I say Financial Statements
I mean the Balance Sheet and Income Statement.
Alright, so welcome back again in MBAbullshit.com.
The topic for this video is Profit Margin
which is one of the measures of profitability
among financial ratios. So, let’s analyze
this ratio now, remember you can always go
back to MBAbullshit.com. This video discusses
and analyzes the profit margin which is one
of my free videos on Liquidity and Profitability
and Market Value which include Current Ratio,
Quick Ratio, Cash Ratio, Profit Margi, ROI
Return On Investment, ROA Return On Assets,
ROE Return on Equity, P/E Price Earnings ratio
and Market to Book Ratio.
After these you can check out my next videos
on MBAbullshit.com such as my video on Financial
Leverage Ratio Critical Analysis which includes:
Total Debt Ratio, Debt-Equity ratio, equity
Multiplier, Times-Interest earned ratio, Cash
Coverage ratio and my other video on Turnover
Ratios Critical Analysis which includes inventory
Turnover, Day’s Sales Inventory, Receivables
Turnover, Day’s Sales Receivables Payable
Turnover, Ave. Days to Pay and Total Asset
Turnover.
Alright, so let’s get down to it. So, let’s
start with a story. Let’s say that ABC Company
has $1000 in Net Income and $2000 in Sales.
What it it’s Profit Margin? It’s very
simple, when it comes to Financial ratio,
the actual ratio is very simple what’s more
important is what the ratio tells you. Okay,
so the computation is simply $1000 divided
by $2000. Where do we get this 1000?-it’s
the net income. Where do we get the 2000?-It
is the Sales. We divide that by each other
and we find we have a profit margin of 0.5
or 50% which is quite high I think. Now, but
after you see later, high or low it’s relative
depending on what you compare it against whether
you compare it with similar company or you
compare it with your historical profit margin
of your company or of this company.
Alright, so what does the 50% profit means?
Well, simply it means every time the company
makes $100 in Sales it makes on the average
a fifty-dollar profit, okay. So, that’s
what it means. Therefore, a higher profit
margin is usually considered better. However,
there are some flaws in using this ratio.
Some companies can have a very low profit
margin but still be very profitable for example
Wal-Mart. Why is Wal-Mart so successful? Well,
the many reasons why Wal-Mart is successful
but I guess the main reason why Wal-Mart is
successful is it’s very cheap. And one of
the reasons why it’s very cheap is because
Wal-Mart has a low profit margin. So, they
don’t add much profit between the cost of
the stuff they’re selling and the actual
sales. So Wal-Mart has low profit margin but
huge volume profit in the end. If Wal-Mart
would try to increase its profit margin the
prices would go up and that they would lose
volume and they probably would become not
profitable. People would go to Wal-Mart because
it’s cheap.
The second flaw in using this ratio is that
a high profit margin does not necessarily
mean high cash flow. Remember, Financial managers
prefer Cashflow over “Profit”, instead
of profit. So, in some cases not in the cases
of Wal-Mart which is cash basis. But in some
companies, a company might have a high profit
margin because of accrued sales and not cash
sales. Accrues Sales means you made a sale
but then the costumer hasn’t paid you yet
for the service. So, if you already made the
sale but the costumer hasn’t paid you, it
will still appear as a sale in your income
statement. And therefore you might not be
able to benefit yet from this profit because
the cash part of the profit or you might get
the cash very far into the future.
There are also some Traditional ways of analyzing
financial ratios and the first is to compare
for historical profit margin of your company.
Compare your most recent profit margin with
last year’s profit compare it with your
historical profit. If your profit margin is
higher now than last year’s then it night
indicate better cost and expense management
than before and may also indicate, I use indicate
because it’s not 100% sure, it’s just
an indicator and on a more profitable company
If your profit margin is lower than the last
year’s then this must indicate a lousier
cost and expense management than the earlier
years and on the last profitable company.
The next thing you do in the Traditional Analysis
of Financial ratio is to compare with other
similar companies. I stress similar because
it’s useless to compare Wal-Mart to a Car
Company like Toyota. Obviously, a car company
would have very high profit margin but less
than. A car company not Toyota, a car company
maybe, a car company like Ferrari, obviously
a car company like Ferrari would have a high
profit margin but they have low volume. Wal-Mart
would have a very low profit margin but high
volume. So, when you look at the profit of
Wal-Mart , it’s best compared to the profit
margin of Target for example. If your profit
margin is high than theirs then this might
indicate proper cost and expense management
than theirs and it might indicate a more profitable
company. If the profit margin is lower than
theirs, then this might indicate lousier cost
and expense management than them and/or a
less profitable company.
Alright, so there you have it. Remember to
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a great day and goodbye.
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