Do you intend to do a basic study of the businesses in which you want to invest? However, before you do so, you need to be sure that you have checked the turnover ratios, which will assist you in determining how effectively the business is putting its assets to use in order to generate money.
The turnover ratios are a useful tool for determining how well a business generates income from its assets and how effectively it operates overall.
It does this by comparing the sales data to the various assets, with the goal of determining what proportion of the assets are responsible for creating the amount of sales.
To ensure that a company is able to continue its operations, it must have access to a variety of assets. These assets must be capable of bringing in sufficient income for the company.
These ratios are classified as efficiency ratios since they assist in determining how effectively a firm makes use of its various assets in order to achieve its revenue goals.
Therefore, while doing a fundamental study of the business in which you want to invest, it is important to examine the following ratios in order to evaluate the effectiveness of the organisation.
What exactly is meant by a “turnover ratio”?
This ratio indicates how much of an organization’s assets or liabilities are being replaced in comparison to its sales. It might be positive or negative.
This idea is helpful for determining how well a company is putting its resources to use in order to grow its business.
A high asset turnover ratio is generally seen as a positive indicator for a company since it demonstrates that receivables are rapidly collected and that only a small amount of surplus inventory is maintained on hand.
This demonstrates that there is a low requirement for the money that are invested, which ultimately results in a good return on investment.
The Inventory Turnover Ratio
The Inventory Turnover Ratio represents the frequency with which the inventory is changed into sales.
This statistic may be explained in layman’s terms as a measurement of the company’s ability to generate revenues from the sale of its inventory.
The following is the formula that must be used to calculate this ratio:
The inventory turnover ratio is calculated by dividing the cost of items sold by the average inventory.
A higher ratio is preferable since it increases the likelihood that items will be delivered to consumers on time.
The ratio of a firm’s sales
to its fixed assets is known as the fixed asset turnover ratio. This ratio indicates how well a company uses its fixed assets to generate sales.
This ratio is appropriate for use in labor-intensive businesses such as manufacturing, which need a significant amount of capital for various expenditures. As a consequence of this, the ratio is also used for the purpose of comparing the firms operating within the respective sectors.
The following is the formula that must be used to calculate this ratio:
The ratio of net sales to gross fixed assets less accumulated depreciation is known as the fixed asset turnover ratio.
It is important to keep in mind that the ratio indicates how well a firm is using its fixed assets. This indicates that a company can produce sales with a minimal amount of fixed assets without needing to raise any more cash.
The ratio of a firm’s accounts
receivable to its total assets is referred to as the accounts receivable turnover ratio. This ratio is used to determine how well a company is collecting revenue and using its assets.
This ratio calculates the average number of times, over a given time period, that an organisation collects the average amount that it owes in accounts receivable.
The following is the formula that must be used to calculate this ratio:
Net credit sales divided by average accounts receivable is the formula used to calculate the accounts receivable turnover ratio.
Where:
Sales made on credit when the cash is recovered at a later date are referred to as “net credit sales.” The equation for calculating net credit sales is as follows: net credit sales = sales on credit minus sales returns minus sales allowances.
The total of a time period’s beginning and ending accounts receivable, divided by the number of periods in the time period (such as monthly or quarterly), yields the average accounts receivable.
A high ratio is generally desired since it demonstrates that the company’s collection of accounts receivable occurs on a more regular basis and with more effectiveness.
Accounts Payable Turnover Ratio:
The accounts payable turnover ratio, also known as the creditors turnover ratio, is a ratio that determines the average number of times that a firm pays its creditors over the course of a certain period of time.
This ratio is a measurement of the company’s short-term liquidity, and a more favourable payable turnover ratio is one that has a greater value.
The following is the formula that must be used to calculate this ratio:
Receivables From Customers The turnover ratio may be calculated as follows: net credit purchases divided by the average accounts payable.
In some instances, the cost of goods sold (COGS) is substituted for net credit purchases inside the numerator of the calculation. The total of accounts due at the beginning of an accounting period and accounts payable at the conclusion of the period are added together and then divided by 2.
Capital Employed Turnover Ratio:
This ratio indicates how well the organisation generates revenues from the capital that it has on hand.
This ratio not only assists investors in deciding whether or not the company is able to create revenues from the capital that it has invested, but it also serves as a significant component for determining whether or not the company should be loaned further funds.
The following formula may be used to calculate this ratio:
The ratio of net sales to total capital employed is the capital employed turnover ratio.
The higher the ratio, in general, indicates a better use of the capital employed by the company, as well as the company’s potential to generate the greatest amount of profits with the least amount of capital employed, hence a higher ratio is often seen as a positive indicator.
Investment Fund Turnover:
This ratio is mostly used in connection to investment funds and refers to the percentage of investment assets that have been replaced in any given year. It is most often used in the context of investment funds.
If the ratio is low, it indicates that the fund management is not paying a significant amount of brokerage transaction costs when selling or purchasing shares.
The investing strategy used by a fund manager will determine the quantity of turnover experienced by the fund.
Therefore, a fund manager who employs a “buy and hold” strategy will have a low ratio, but a manager who employs a more active approach would suffer a high ratio and will need to deliver bigger returns in order to offset the increased transaction costs.
Where can I get a company’s above-mentioned turnover percentages to examine them?
Using StockEdge, the investor may evaluate the aforementioned ratios of any firm in which they are considering investing their money for the long term.
The fundamental scans available on StockEdge identify those businesses that are suitable for long-term investment and exclude those that are not.
In a nutshell, these ratios demonstrate how effectively the organisation is employing its assets for the purpose of creating money, as was covered in the preceding section. Therefore, you can choose whether or not you should invest in a given firm by using the ratios that have been shown above.
