Efficiency Ratios-Inventory turnover, Receivable turnover, Payable turnover, Fixed asset turnover

Ratio analysis is an important way to analyse a company’s financial statements, they measure various aspects of a company’s operating and financial performance. Input to calculate ratio’s come from the financial statements.

Ratios can be classified into 4 broad categories namely:
Efficiency ratios
Liquidity & solvency ratios
Profitability ratios
Valuation ratios

Efficiency ratios are also known as activity ratios, they measure how efficiently the company performs its day to day operations.

The important efficiency ratios discussed are:
(* All ratios in this video are calculated for the whole year)
Inventory turnover ratio
Receivable turnover ratio
Payable turnover ratio
Fixed asset turnover ratio

Inventory turnover - measures how many times and how fast a company has sold its inventory in the year

The inventory turnover ratio is calculated as
Inventory turnover = COGS/ Average inventory

The Inventory turnover ratio for Star Motocorp was (*All figs are in Rs. Million)

200000/5000 = 40 Times, meaning it sold its inventory 40 times during the year

Inventory days are the number of days it takes a company to sell its inventory. Is calculated as = No of days in a period/Inventory turnover.

Inventory days for Star Motocorp for FY17 was
365/40 = 9 days, meaning they sold their inventory every 9 days
Lower inventory days can mean the company sells out its inventory quickly or it is not stocking the correct amount of inventory. An investor needs to study the financial statements of the company in detail to find out the exact reason for the same.

Receivable turnover – Measures the efficiency with which a company collectes cash from its debtors/customers.

The receivable turnover ratio is calculated as
Receivable turnover – Sales/ Average receivables
The receivable turnover ratio for Star Motocorp was
305000/12000 = 25.41, meaning they had collected cash 25.41 times from its customers during the year
Recievable days for Star Motocorp was
365/25.41 = 14 days

Meaning the company collected cash from its customers every 14 days
Lower receivable days means that the company is efficient and fast in collecting cash from its customers and is a good sign.

Payable turnover – measures the no of times a company pays its creditors/suppliers from whom it has purchased raw materials during the year

The payable turnover ratio is calculated as
Payable turnover = COGS/ Average payables

Payable turnover for Star Motocorp was
200000/30000 = 6.66, signifying the company paid its suppliers 6.66 times during the year

Payable days of Star Motocorp was = 365/ 6.66 = 54 days.
Star Motocorp paid its suppliers once in every 54 days

Higher payable days can indicate that the company is enjoying favourable credit terms or is unable to pay its suppliers. An investor needs to study the company’s financial statements to find out the reason for the same

Fixed asset turnover – Measures the efficiency of a company in managing its fixed assets.

It is calculated as Fixed asset turnover – Sales/ Average net fixed assets.

The fixed asset turnover for Star Motocorp was
305000/40000 = 7.6, It signifies that for every 1 Re of fixed assets that the company had it generated sales of Rs 7.6

A higher ratio needs to be seen in positive light.

It is very important for investors to study all ratios over a period of time and compare them across different companies in the same sector/industry.