Classify the various Turnover/Activity/Performance Ratios. Also explain the meaning, method of calculation and objective of these ratios.
Answer:
Classification of Turnover/Activity/Performance Ratios: -
1. Capital Turnover Ratio
2. Fixed Assets Turnover Ratio (CBSE 1998, 2000, Outside Delhi 2001)
3. Working Capital Turnover Ratio (CBSE Outside Delhi 2001)
4. Stock Turnover Ratio (CBSE 1989, 2000, Outside Delhi 2001)
5. Debtors Turnover Ratio (CBSE Outside Delhi 2001, Delhi 2002)
6. Debt Collection Period
Meaning, Objective and Method of Calculation: -
1. Capital Turnover Ratio: Capital turnover ratio establishes a relationship between net sales and capital employed. The ratio indicates the times by which the capital employed is used to generate sales. It is calculated as follows: -
Capital Turnover Ratio = Net Sales/Capital Employed
Where Net Sales = Sales – Sales Return
Capital Employed = Share Capital (Equity + Preference) + Reserves and Surplus + Long-term Loans – Fictitious Assets.
Objective and Significance: The objective of capital turnover ratio is to calculate how efficiently the capital invested in the business is being used and how many times the capital is turned into sales. Higher the ratio, better the efficiency of utilisation of capital and it would lead to higher profitability.
2. Fixed Assets Turnover Ratio: Fixed assets turnover ratio establishes a relationship between net sales and net fixed assets. This ratio indicates how well the fixed assets are being utilised.
Fixed Assets Turnover Ratio = Net Sales/Net Fixed Assets
In case Net Sales are not given in the question cost of goods sold may also be used in place of net sales. Net fixed assets are considered cost less depreciation.
Objective and Significance: This ratio expresses the number to times the fixed assets are being turned over in a stated period. It measures the efficiency with which fixed assets are employed. A high ratio means a high rate of efficiency of utilisation of fixed asset and low ratio means improper use of the assets.
3. Working Capital Turnover Ratio: Working capital turnover ratio establishes a relationship between net sales and working capital. This ratio measures the efficiency of utilisation of working capital.
Net working capital represents organization’s operating liquidity. In order to compute the net working capital, total current assets are divided from total current liabilities. When there is sufficient excess of current assets over current liabilities, an organization might be considered sufficiently liquid. Another ratio that helps in assessing the operating liquidity of as company is a current ratio. The ratio is calculated by dividing the total current assets over total current liabilities. When the current ratio is high, the organization has enough of current assets to pay for the liabilities. Yet, another mean of calculating the organization’s debt-paying ability is the debt ratio. To calculate the ratio, total liabilities are divided by total assets. The computation gives information on what proportion of organization’s assets is financed by a debt, and what is the entity’s ability to pay for current and long term liabilities. Lower debt ratio is better, because the low liabilities require low debt payments. To be able to lend money, an organization’s current ratio has to fall above a certain level, also the debt ratio cannot rise above a certain threshold. Otherwise, the entity will not be able to lend money or will have to pay high penalties. The following steps can be undertaken by a company to keep the debt ratio within normal
Total Asset Turnover. The total asset turnover ratio is calculated using the organizations sales with regard to its total assets. It is indicative of an organizations efficiency and its ability to generate sales by using its total assets. A higher number is a more appealing ratio, here as it tells us the company is “generating more revenue per dollar of assets (Investopedia.com, 2016)”. Again, Happy Hamburger falls below the industry average of 3, coming in at 1.69 before the increases and 2.11, after. These numbers are not terrible but don’t meet the industry average and would be considered a
The Return on Capital Employed (ROCE) ratio is a profitability ratio that measures how well profits are being generated based on capital employed. RadioShack’s ROCE dropped down to -34% in 2013 in comparison to 10% in 2012. For every dollar of capital employed, RadioShack is losing $0.34. The dramatic dip stems from 2012’s positive earnings before interest and taxes (EBIT) of 155.1 million dollars to 2013’s EBIT of -344 million dollars. Capital employed is determined by subtracting current liabilities from total assets. In 2013, capital employed decreased by 79 million dollars. ROCE is used to view the long-term profitability of firms. A more in-depth trend analysis done over several years would need to be done to determine the
Return on sales is decreasing and is below the industry average, but the goods news is that sales and profits have been increasing each year. However, costs of goods are increasing and more inventory is left over each year causing the return on sales to decrease. For 1995, it was 1.7% which is less than the average of 2.44% but is a lot higher than the bottom 25% of companies as seen in exhibit 3, which actually have negative sales return of 0.7%. Return on equity is increasing each year and at a higher rate than industry average. In 1995, it was 20.7%, greater than the average of 18.25% and close to the highest companies in exhibit 3, of 22.1% showing that the return in investment in the company is increasing, which is good for the owner.
The first method we will review is the accounting method. Through this accounting approach we will analyze specific ratios and their possible impact on the company's performance. The specific ratios we will review include the return on total assets, return on equity, gross profit margin, earnings per share, price earnings ratio, debt to assets, debt to equity, accounts receivable turnover, total asset turnover, fixed asset turnover, and average collection period. I will explain each ratio in greater detail, and why I have included it in this analysis, when I give the results of each specific ratio calculation.
Total Asset Turnover – Dropped from .64 in 2001 to .58 in 2002 to .55 in 2003. The reason is big increase in Total Assets.
Ratios for return on assets and return on equity offer support for the loss in stockholders’ equity. Return on assets went from 13.1 in 2000 to 5.1 in 2001 and return on equity dropped from 25.4 in 2000 to 8.7 in 2001. Return on equity represents return on assets divided by the difference of 1 and debts/assets.
Ford’s impressive total asset size is $225 billion (Ford, 2015a). The fixed assets turnover ratio (FATR) illustrates the effectiveness of using fixed assets to generate sales. Ford’s average fixed asset turnover ratio for 2013-2015 is (0.33 for 2015 + 0.32 for 2014 + 0.28) / 3 = 0.31 (Ford, 2015a; Ford, 2015c). Although the number is small, one can compare Ford’s FATR with a competitor during the same period to determine which one uses their fixed assets better. GM’s average FATR for the same period was (0.28 for 2015 + 0.18 for 2014 + 0.14 for 2013) / 3 = 0.2 (GM, 2015a, GM, 2015c). Therefore, one can conclude that Ford’s usage of fixed assets was more productive than GM’s. I will give GM some credit, because of their increasing
In regards to the corporation’s balance sheet, it is necessary to place an importance on liquidity ratios to demonstrate the company’s ability to pay its short term obligations such as accounts payable and notes that have a duration of less than one year. These commonly used liquidity ratios include the current ratio, quick ratio, and cash ratio. All three ratios are used to measure the liquidity of a company or business. The current ratio is used to indicate a business’s ability to meet maturing obligations. The quick ratio is used to indicate the company’s ability to pay off debt. Finally the cash ratio is used to measure the amount of capital as well short term counterparts a business has over its current liabilities.
The ratio of 1.7 for the last two years indicates consistency, although a lower number is preferred. As a company produces high value product, this could be a satisfactory ratio. By comparing it to 2011 when a ratio was 2.9, in the last two years a ratio improved
The inventory turnover decreased from 3.8 to 3.59. This is explained by the higher increase in the average inventory (37%) than the increase in cost of sales (29%) during 2005. This means that the rate at which inventory is sold is dropping
... organization's management. The ratios were broken down into classifications of liquidity and asset utilization, debt and interest coverage, profitability and market-based ratios.
Research on the Sources of Finance for a Business Firms sometimes need to raise finance for Working Capital and Capital Expenditure. Explain what each is and give examples. · Working Capital (or Revenue Expenditure) The working capital is made up of the current assets net of the current liabilities. It is vital to a business to have sufficient working capital to meet all its requirements. Many businesses have gone under, not because they were unprofitable, but because they suffered from shortages of working capital.
This ratio would be the asset turnover. It uses net sales divided by average assets. In 2005, Pepsi Co's asset turnover was at 1.02 while Coca Cola's asset turnover was at 1.06.... ... middle of paper ...
The capital maintenance concept used results in differences between the relevance and faithful representation of the data that appears in the balance sheet and income statement. The difference between financial capital maintenance and physical is the treatment of unrealized holding gains and losses. Financial capital maintenance does not allow for unrealized holding gains and losses. Only realized gains and losses are included in income because they “are considered a return on capital” (Schroeder et al., 2013). This means, “income is measured only after the investment is recovered” (Gamble, 1981). Physical capital maintenance “consider[s unrealized holding gains and losses] as returns of capital and do[es] not include them income.” (Schroeder et al., 2013). Instead, they are treated as adjustments to equity and included in other comprehensive income. Therefore, with physical capital maintenance “an increase in an entity’s wealth as...