![]() Analysts must always be aware of accounting choices and how they affect the calculation of ratios. Therefore, the ratio is very industry specific.Īccounting choices do affect ratios. ![]() It is also affected by the amount of leasing that is done by a company. This number is smaller in capital-intensive industries since they have a higher investment in property, plants and equipment. Total asset turnover is a measure of how many dollars of sales are generated by a dollar of assets.Working capital is defined as current assets minus current liabilities. Working capital turnover measures how efficiently a company generates revenue with its working capital.The following measures the number of days it takes for the company to pay its bills. The longer the time, the better it is for the company, since it is an interest-free loan and offsets the lack of cash from receivables and inventory turnovers. This ratio examines the use of trade credit. Payable turnover measures the length of time a company has to pay its current liabilities to suppliers.An extremely low inventory turnover value implies capital is being tied up in inventory and could signal obsolete inventory. The lower the turnover ratio, the longer the time between when the good is produced or purchased and when it is sold.Īn abnormally high inventory turnover and a short processing time could mean inadequate inventory, which could lead to outages, backorders, and slow delivery to customers, adversely affecting sales. Inventory turnover measures how fast the company moves its inventory through the system.If a company's credit policy is 30 days and the days of sales outstanding is 45 days, then the credit policy needs to be reviewed. For receivables turnover, analysts don't want to derive too much from the norm, since a low number indicates slow-paying customers that cause capital to be tied up in receivables and bad debt and a high number indicates overly stringent credit terms that hurt sales. The nature of the industry dictates a higher or lower receivables or inventory turnover. Remember, as with all ratios, these ratios are industry specific. This ratio also implies an average collection period (the number of days it takes for the company's customers to pay their bills): The same applies for the inventory turnover below. A company could have a favorable current or quick ratio, but if the receivables turn over very slowly, these ratios would not be a good measure of liquidity. This ratio provides a better level of detail than the current or quick ratio. The lower the turnover ratio, the more time it takes for a company to collect on a sale and the longer before a sale becomes cash. Receivables turnover measures the liquidity of the receivables - that is, how quickly receivables are collected or turn over.They measure how well a company manages its various assets. ![]() Activity ratios describe the relationship between the company's level of operations (usually defined as sales) and the assets needed to sustain operating activities. The analyst's primary focus should be the relationships indicated by the ratios, not the details of their calculations.Ī company's operating activities require investments in both short-term (inventory and accounts receivable) and long-term (property, plant, and equipment) assets. The ratios presented in the textbook are neither exclusive nor uniquely "correct." The definition of many ratios is not standardized and may vary from analyst to analyst, textbook to textbook, and annual report to annual report.
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