Inventory Processing period: This measures the number of one day’s worth of inventory a company has on hand at any given time. The formula is:
Payables Turnover period: A lower payable turnover ratio is more favorable to the firm because creditors / trade payables are a source of interest free loans, and if creditors are not paid immediately, the money owed can be invested to generate better returns. The formula is:
Payables payment period: This ratio indicates the number of times that accounts receivable are cycled during the period (usually a year)
A higher payment period is more favorable to the firm, but it should be noted that if the firm tarry’s in paying creditors on a regular basis, the creditors might avoid selling goods to them.
Cash conversion cycle: The cash conversion cycle combines information from the receivables turnover, the inventory turnover and the accounts payable turnover . The formula for the cash conversion cycle is :
Receivables collection days + inventory processing days – payables payment period
Cash conversion cycle helps in measuring the time it takes a company to convert its investment in inventory and other resource inputs into cash.
Operating Efficiency Ratios
Total asset turnover: It shows how the total asset of a firm was utilized in deriving its sales. The total asset turnover ratio indicates the effectiveness of the firm’s use of its total asset base.
The formula for the total asset turnover is
An industry analysis should be used when analyzing this ratio because it varies among industries. For capital intensive industries such as the auto and manufacturing industry, the total asset turnover may be low while it might be high for some retailing or service operation business.
Equity turnover: To calculate the value of equity , you add up common stock, paid in capital and total retained earnings. This ratio can be manipulated by keeping equity constant and constantly increasing debt capital. So care should be taken when doing it. Equity turnover seeks to measure how efficiently management is using equity to generate sales or revenue.
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