Operating Ratios

...these measures provide an assessment of a company's operating efficiency.


By linking various income statement and balance sheet figures, these measures provide an assessment of a company's operating efficiency.

• Asset turnover. This shows how efficiently a company uses its assets. To calculate asset turnover, divide revenue by total assets. The higher the number the better.

• Days receivables. It's best to collect on receivables promptly. This measure tells you in concrete terms how long it actually takes a company to what it's owed. A company that takes forty-five days to collect its receivables will need significantly more working capital than one that takes four days to collect. There are different methods to calculate days receivables. One way is to divide ending accounts receivable by revenue per day.

• Days payables. This measure tells you how many days it takes a company to pay its suppliers. The more days it takes, the longer a company has cash to work with. There are different methods to calculate days payables. One way is to divide ending accounts payable by cost of goods sold per day.
  

• Days inventory. This is a measure of how long it takes a company to sell the average amount of inventory on hand during a given period of time. The longer it takes to sell the inventory, the more the company's cash gets tied up and the greater the likelihood that the inventory will not be sold at full value. To calculate days inventory, divide average inventory by cost of goods sold per day.

ACTION ITEM: Evaluate your operation through the ratios above.