A company's job is to turn revenue into profit. Money comes in and the company tries to keep as much of it as it can.
An efficiency ratio measures how well a company does that. It looks at how effectively the company uses its expenses. A weak efficiency ratio means the company has a lot of slack in its operations...it's giving away a lot of money unnecessarily, or at least not using its assets ideally. A strong efficiency ratio means the company does a good job of turning its revenue into profit.
The idea of an efficiency ratio comes up a lot when evaluating banks. Companies (and analysts/investors looking at those companies) can see how much revenue gets eaten up by overhead. Also, it allows the banks (and anyone looking at them) to review how well they turn assets into revenue.
Related or Semi-related Video
Finance: What is marginal cost?41 Views
Finance allah shmoop what is marginal cost All right let's
start with profits No different profits Gross operating net those
kind of profits Those are the big three for now
Anyway if you don't recall the income statement that gave
you those margins well here it is in all its
glory Our awesome lemonade stand So from a resource is
allocation perspective margins drive everything you ever read Animal farm
Well if you look in the very fine print you'll
see that it really says high margins good higher margins
better But margins are a contextual thing They're evaluated on
a relative basis Basically the more of a commodity Something
is generally speaking the more rivalrous the industry there in
meaning tons and tons of sellers all competing on price
for the same product and thus lower margins for that
highly competitive industry Think about the very mature in declining
paper in pulp industry long history tons of competitors They
all sell the same old dead tree product There's almost
no differentiation between one seller or another of paper and
pulp And they're filled with unions Yeah way low margin
world less and less demand for paper and paul peach
Year is everything moves online Polluters mostly overseas have a
structural advantage over non polluters because it's cheaper to make
paper pulp when you could just pollute dump everything in
the river right Well in the us where houser is
the paper and pulp gorilla And in a great year
this very commoditized company filled with union workers has only
ten ish percent margins where houser sells a ton of
pulp for some three grand or so which cost it
just two grand and change to manufacture But then if
you add in operating costs like shipping union pension funds
senior management lawyers rent and more lawyers will even its
scale that three grand of revenues from a ton of
pulps sold cost warehouses something well over twenty five hundred
bucks So that pretax they only make five hundred box
or less from every three grand of revenues right that
be their operating margin there Well compare warehouses with google's
search business Google owns the world in the search category
with over eighty percent of all searches going to its
servers Essentially no riel competitors today Sorry microsoft Just keeping
it real Google makes money by selling virtual real estate
Or cliques and views a typical click on ah highly
big keyword like taxes help or mesothelioma Ambulance chasing lawyers
is something like fifty cents per click or more Well
google's marginal cost for that click Well not a lot
the electricity to serve the page but well that's about
it Call it a penny So google search business alone
is like a ninety percent plus gross margin kind of
business Pretax They have almost no marginal cost of goods
sold Really amazing business way different from twenty five hundred
dollars to sell three grand worth of pulp Google has
no cost of shipping and a small handful of highly
paid engineers a call in a few hundred of them
who actually matter to the process today Well they created
a mathematical algorithm that truly scales meaning it gets bigger
and more profitable The bigger it grows well the marginal
additional cost of one more click to google is almost
nothing and it's a vast contrast to that paper and
pulp business where yet more forests have to be planted
more lumberjacks need to be hired and then probably injured
More trees need to be killed and shift and chemically
altered with bleach and on and on and on so
relative to its competitors wear hauser might be doing great
with ten percent plus margins But the fact is the
paper and pulp business is a lousy industry a lousy
business when compared with the search industry Who's n plus
one thor Additional units sold Cost google almost nothing The
basic idea is that you have to understand margin in
the context of an industry and in the context of
an economic climate that could be good bad and or 00:04:09.298 --> [endTime] ugly
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