Imagine yourself as a manager in a bustling corporation, navigating the complexities of financial management. Gabriel Goldbrain, a seasoned management consultant, emphasizes the pivotal role of understanding financial ratios in your journey to success. Goldbrain stresses the importance of analyzing financial ratios over multiple years, allowing you to discern patterns and identify exceptional periods. As a manager, you're tasked with deciphering the factors influencing these financial ratios for managers, presenting your findings to senior management with clarity and insight. Meeting KPA targets is essential for ensuring organizational success and growth.

Financial ratios are relevant for employees, suppliers, and customers alike. Whether assessing a company's health or negotiating terms, identifying KPAs, familiarity with financial ratios is invaluable. KPAs guide our focus on efficiency and quality.

Delving into the five fundamental financial ratios, Goldbrain provides clear explanations and practical examples. From net profit margin to return on equity, gross profit margin, debt ratio, return on assets, each ratio offers unique insights into a company's financial health and performance. Each department has its own set of KPAs to focus on for achieving overall objectives.

Consider the net profit margin, which reveals the percentage of profit generated from revenue. By comparing this ratio across competitors, you can identify areas for improvement and strategic decision-making, such as adjusting product offerings or optimizing operations. Regular KPA assessments help us stay on track and adapt to changing market demands.

Similarly, the return on assets and return on equity ratios shed light on a company's efficiency and profitability. Understanding these financial ratios for managers empowers you to evaluate investment opportunities and gauge management effectiveness.
Whether you're a seasoned executive or a budding entrepreneur, mastery of financial ratios for consultants is key to achieving sustainable success.

In conclusion, financial ratios for managers are more than just numbers—they're powerful tools for unlocking the full potential of your business. Embrace this knowledge, and watch as your ability to drive positive change and foster prosperity reaches new heights.

Video transcript:

Hard to imagine that you'd ever become a successful manager in a big corporation without knowing financial ratios. Today, I'm going to talk about the five most fundamental financial ratios every manager and CEO should know. Management consultants who give advice to managers should even know more financial ratios.

And if you're planning to become a management consultant, I've developed the GoldBrain Success Training where you learn many more financial ratios than in this video. If you're interested, visit my website www.gabrielgoldbrain.com.

When you talk about financial ratios, usually a single year is not really that interesting. You should rather consider the same ratio over 3 years, preferably 5 years, and ideally a decade. That way, you can easily spot changes in the margin and identify exceptional years or periods. Once you've identified an exceptional ratio change, you may want to understand what were the influencing factors, what was the reason that the ratio changed. And that is typically the task that every manager has to do when the senior management meets. Every manager has to explain his ratios and talk about what led to exceptional changes in his ratios. Sometimes you may even want to normalize a ratio for certain impacts because you want to show to the senior management how the ratio looked like without this special event that changed the ratio. And for that reason, it's very important that you have a clear understanding of how the ratios for which you are responsible are being calculated and what influence factors may change these ratios.

Let's now talk about the key financial ratios to assess the strength and financial condition of a company. Even as an employee, as a supplier, and as a customer, you should know these figures because that way you can assess the healthiness of the company you're dealing with. That means if you work for a company or if you deliver goods to a company or if you purchase goods from a company that publishes annual reports, half-yearly or quarterly reports, it's always worthwhile to investigate these numbers and to calculate certain margins. We're now going to talk about because as an employee, you may want to know, did the company do well in the last quarter? So maybe they even posted an exceptional profit which is good if you want to negotiate for a higher salary. And maybe it's not the right situation if the company just had the worst quarter in its history. As a customer, let's say if you're buying a house from a house building company, you want to know if the company is in good financial condition so that they can build a house for you and that there is no risk or a low risk that they go bankrupt and you're left there without a house and having paid maybe too much for it already. And now you have all the hassle to find someone new to continue building it. The same applies to suppliers you deliver your goods and then maybe the company is not able to pay so you should ask cash advance and that you can see from the balance sheet if you analyze the balance sheet and the profit and loss statement. These will give you good indications.

But now let's start with ratio number one: net profit margin.Take net profit, divide it by revenue. That tells you for every dollar or for every Euro being turned over, what percent of profit it generates. Let's make an example. For instance, a car dealer may have sold cars worth 10 million excluding VAT. Then at the year-end, after deducting all the costs for acquiring and purchasing the cars, for his sales employees, and all the administration tasks, 500,000 are left in his pocket. So, what would be the net profit margin of that business? It's quite easy. You divide 500,000 by 10 million and so that gives a net profit margin of 5%. So, what does that tell you about this car dealer? You could compare his net profit margins to other car dealers in the region or in the country, and you may find out there are some which only make 3% net profit margin and there are others which maybe make 7 or 12% net profit margin. And then you could start thinking about why is there a difference, what does the other car dealer do differently. And based on such a comparison, every owner of a car dealership should do some kind of analysis like this where he reasons about do I have the right cars? Should I go into higher value cars instead to improve my margin? Do I have to offer more cars? Should I increase the size of my car dealership? Should I build a new yard and then offer more cars? Or he could reason, am I overstaffed? Do I have to reduce staff numbers? All these questions should be answered following a number of ratio comparisons. If you look at such a ratio like the net profit margin over a period of time, let's say the last 5 years or a decade, you can easily spot changes. Maybe you're part of a big corporation and you brought in a new manager 5 years ago or with the example of the car dealership, your son took over 5 years ago. Then you may reason and see since he started, numbers improved or numbers deteriorated. And that is the starting point for looking at other ratios.

One such ratio is the gross profit margin. This is the second ratio we're going to look at. You calculate the gross profit margin by taking the net profit divided by the gross profit. For all of you not familiar with a gross profit, it's pretty much the revenue less the cost of producing the goods that generated the revenue. This includes related labor cost and production-related depreciation as well. For example, if you sell a car for 20,000 that you bought before for 12,000 and then you put in some money to do some fixes and repairs, let's say 2,500, and then while you did the repairs, a tool with which you repair the car broke maybe let's say for 500. That's the worth, that's the value of that tool that broke. Then you have cost of 15,000 for getting the car into that state in which it was sold. And to now get to the gross profit for this car, you take the 20,000, subtract the so-called cost of goods sold which are the 15,000, and then you end up at 5,000 for the gross profit. If you then deduct all the remaining costs, for instance, for the salesman, for the accountant, for your salary, and if then maybe 1,000 remains, then your gross profit margin would be 20%. So, for what is now that gross profit margin ratio good? You could for instance see if the prices for cars that you purchase if they rise, then you will see it by a decreased gross profit margin assuming that you were not able to pass on the increased prices. Similarly, if you manage to sell the same car which you buy for 12,000 and then you fix it, when you are able to sell it for 21,000, 22,000, 23,000, that will have a significant impact on the gross profit margin and then you see the gross profit margin rising. To come back to the car dealership example where the son took over 5 years ago and then he maybe started selling higher value cars and then you see suddenly the gross profit margin rising. So, your hypothesis you could derive from that analysis might be that selling the more high-value cars that this could be well the reason for the increasing gross profit margin and with it the increasing net profit margin. And from here, you can see how one analysis may lead to another analysis and to hypotheses that you develop about the reasons why things changed. For sure, you would need to confirm your hypothesis by further analysis but this was a good example how management consultants or managers derive certain hypotheses from margins or ratios they look at.

Return on assets

Next one, return on assets. What does that mean? You take the net profit and then you divide it by the total to asset which means everything that the company owns. The return on assets helps you to assess the capital intensity of a business. Let's assume you run a business which has a balance sheet and total assets of 50 million and the business only generates 1 million in net profit. That means your return on assets is 2%. So, that business is very capital intense. If you run a capital intense business, you have certain risks. For instance, inflation. If you have high inflation, your capital requirements may go through the roof and the margins may suddenly be gone because they just don't generate enough profit. Capital intense businesses are businesses for instance like the airline industry, the steel industry, maybe the tanker industry, reas things like that often they're able to generate huge cash flows because they have very high depreciation values and therefore it's very important to assess for a capital intense business if it's underinvested. For instance, if you purchase such a business on the other hand there are capital light businesses for instance like a Google, a Coca-Cola, they don't require a lot of capital to provide the products and therefore they're doing much better in inflationary scenarios.

A related ratio is our fourth ratio it's return on equity. Instead of dividing net profits by total assets, you take net profit divided by equity. That means the funds that the shareholders contributed or that belong to the shareholders. The expected return on equity is typically twice or three times the value which you have for return on assets. This number tells an investor how much he can earn from all the assets that the company holds. Management can influence that number. The return on equity instead of asking shareholders to provide funds for new investments, the management may ask banks to do so. During the last decades, we had a low-interest environment so it was very attractive for shareholders and therefore for the management to lend money that way shareholders could significantly improve the return on equity.

Return on equity is related to our last the fifth ratio the debt ratio. The debt ratio is calculated by taking total liabilities divided by total assets and simply said that expresses what percentage of the balance sheet is lended money. 30% and less lended money is considered conservative whereas nowadays you have often ratios exceeding 50% due to rising interest rates I expect these ratios to drop in the future because companies want to deleverage because the cost of capital increased.

As always I prepared a slide to summarize the ratios which we discussed let me give you one more comment on the net profit ratio as I forgot to do so before a good net profit margin is about 10% 20% is an exceptional net profit margin and you will like not see that with many companies more common are net profit margins in the single digits similarly return on assets 10% is a very good return on assets you will seldomly see 20% or more and more often find ratios in the single digits return on equity 20% is an excellent return on equity you will seldomly find more unless unless the company maybe is overleveraged in most cases returns on equity are somewhere between 10 and 15% in some cases even in the single digits all these ratios we are talking about are heavily dependent on the underlying industry so you can use these to compare industries to compare companies within industries so they provide a handy tool set for managers and management consultants if you want to become a management consultant or download this slide visit my website www.GabrielGoldBrain.com if you ad my ratios and found out that you have optimization potential for your company I have two more videos for you the first one is about Porter five forces and the second one about a funnel analysis I will explain how you can apply these to dig deeper subscribe to my channel thanks for watching.