AAKASHAYA PATRA SEVEN STAR SMART EDUCATION SERIES PART – 57 : 13.09.2020

 

Financial Ratios

 

Management Efficiency Ratios

 

Last week we had seen details about Return on Equity (ROE), Return on Capital Employed (ROCE) and Return on Asset (ROA). This week we shall try to understand Liquidity Ratios.

Management Efficiency Ratios help us to evaluate the ability of the management to use its assets and manage its liabilities effectively.

Commonly used Management Efficiency Ratios include –

1. Fixed Asset Turnover Ratio

2. Working Capital Turnover Ratio

3. Total Asset Turnover Ratio

4. Inventory Turnover Ratio

5. Inventory Number of Days

6. Receivables Turnover Ratio

7. Days of Sales Outstanding

Fixed Asset Turnover Ratio:

The fixed-asset turnover ratio is the ratio of net sales to the fixed assets of the company. Fixed Asset Turnover Ratio = Net Sales / Average Net Fixed Assets This ratio is used to measure the operating performance of the company, i.e., how efficiently a company is producing sales with its machines and equipment. In general, a higher fixed-asset turnover ratio indicates that a company has more effectively utilized investment in fixed assets to generate revenue.

A declining ratio needs to be analyzed to understand if it is bad or good. It may be because of decline of sales or may be due to increase in fixed assets which may be because of expansion carried out by the company and its results are yet to be seen in company's performance.

Like ROA, the fixed asset turnover ratio reflects the capital intensity of the company. The number will be different for different industries. Hence you must make use of fixed asset turnover ratio to compare companies in the same industry. 

Working Capital Turnover Ratio:

First let us try to understand working capital. It is the capital required by a company to run its day to day operations. It is calculated as the current assets minus the current liabilities.

 A positive value is considered to be working capital surplus indicating that the company can easily manage its day to day operations.  However a negative value is considered to be working capital deficit indicating that company needs a working capital loan to manage its day to day operations.

 Working capital turnover ratio is the ratio of net sales of the company to its working capital. This ratio gives an indication of a company's effectiveness in using working capital.

 Working Capital Turnover Ratio = Net Sales / Average Working Capital

A high working capital turnover ratio indicates that management is being extremely efficient in using a company's short-term assets and liabilities to support sales. Conversely, a low ratio indicates that a business is investing in too many accounts receivable and inventory assets to support its sales, which could eventually lead to an excessive amount of bad debts and obsolete inventory.