Financial Ratio Tutorial

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By Richard Loth
(Contact | Biography)

When it comes to investing, analyzing financial statement information (also known as

quantitative analysis), is one of, if not the most important element in the fundamental
analysis process. At the same time, the massive amount of numbers in a company's
financial statements can be bewildering and intimidating to many investors. However,
through financial ratio analysis, you will be able to work with these numbers in an organized
fashion.

The objective of this tutorial is to provide you with a guide to sources of financial statement
data, to highlight and define the most relevant ratios, to show you how to compute them
and to explain their meaning as investment evaluators.

In this regard, we draw your attention to the complete set of financials for Zimmer
Holdings, Inc. (ZMH), a publicly listed company on the NYSE that designs, manufactures
and markets orthopedic and related surgical products, and fracture-management devices
worldwide. We've provided these statements in order to be able to make specific reference
to the account captions and numbers in Zimmer's financials in order to illustrate how to
compute all the ratios.

Among the dozens of financial ratios available, we've chosen 30 measurements that are the
most relevant to the investing process and organized them into six main categories as per
the following list.

Pasted from <http://www.investopedia.com/university/ratios/>

Debt Ratios: Overview Of Debt

By Investopedia A A A
Filed Under: Beginning Investor, Cash Flow Statement, Debt/Equity, Financial
Statements,Fundamental Analysis, Solvency, Solvency Ratio Fundamental
Analysis, Beginning Investor,Cash Flow Statement, Debt/Equity, Financial
Statements, Solvency, Solvency Ratio
By Richard Loth (Contact | Biography)

Before discussing the various financial debt ratios, we need to clear up the
terminology used with "debt" as this concept relates to financial statement
presentations. In addition, the debt-related topics of "funded debt" and credit
ratings are discussed below.

There are two types of liabilities - operational and debt. The former includes
balance sheet accounts, such as accounts payable, accrued expenses, taxes
payable, pension obligations, etc. The latter includes notes payable and other
short-term borrowings, the current portion of long-term borrowings, and long-
term borrowings. Often times, in investment literature, "debt" is used
synonymously with total liabilities. In other instances, it only refers to a
company's indebtedness.

The debt ratios that are explained herein are those that are most commonly
used. However, what companies, financial analysts and investment research
services use as components to calculate these ratios is far from standardized. In
the definition paragraph for each ratio, no matter how the ratio is titled, we will
clearly indicate what type of debt is being used in our measurements.

Getting the Terms Straight

In general, debt analysis can be broken down into three categories, or
interpretations: liberal, moderate and conservative. Since we will use this
language in our commentary paragraphs, it's worthwhile explaining how these
interpretations of debt apply.
 Liberal - This approach tends to minimize the amount of debt. It includes
only long-term debt as it is recorded in the balance sheet under non-
current liabilities.
 Moderate - This approach includes current borrowings (notes payable) and
the current portion of long-term debt, which appear in the balance sheet's
current liabilities; and, of course, the long-term debt recorded in non-
current liabilities previously mentioned. In addition, redeemable preferred
stock, because of its debt-like quality, is considered to be debt. Lastly, as
general rule, two-thirds (roughly one-third goes to interest expense) of the
outstanding balance of operating leases, which do not appear in the
balance sheet, are considered debt principal. The relevant figure will be
found in the notes to financial statements and identified as "future
minimum lease payments required under operating leases that have initial
or remaining non-cancel-able lease terms in excess of one year."
 Conservative - This approach includes all the items used in the moderate
interpretation of debt, as well as such non-current operational liabilities
such as deferred taxes, pension liabilities and other post-retirement
employee benefits.
Note: New accounting standards, which are currently under active
consideration in the U.S. by the Financial Accounting Standards Board (FASB)
and internationally by the International Accounting Standards Board (IASB), will
eventually put the debt principal of operating leases and unfunded pension
liabilities in the balance sheet as debt liabilities. Formal "Discussion Papers" on
these issues are planned by FASB and IASB in 2008, with adoption of the
changes following the discussion phase expected in 2009.
Investors may want to look to the middle ground when deciding what to include
in a company's debt position. With the exception of unfunded pension liabilities,
a company's non-current operational liabilities represent obligations that will be
around, at one level or another, forever - at least until the company ceases to
be a going concern and is liquidated.
Also, unlike debt, there are no fixed payments or interest expenses associated
with non-current operational liabilities. In other words, it is more meaningful for
investors to view a company's indebtedness and obligations through the
company as a going concern, and therefore, to use the moderate approach to
defining debt in their leverage calculations.

So-called "funded debt" is a term that is seldom used in financial reporting.

Technically, funded debt refers to that portion of a company's debt comprised,
generally, of long-term, fixed maturity, contractual borrowings. No matter how
problematic a company's financial condition, holders of these obligations,
typically bonds, cannot demand payment as long as the company pays the
interest on its funded debt. In contrast, long-term bank debt is usually subject
to acceleration clauses and/or restrictive covenants that allow a lender to call its
loan, i.e., demand its immediate payment. From an investor's perspective, the
greater the percentage of funded debt in the company's total debt, the better.

Lastly, credit ratings are formal risk evaluations by credit agencies - Moody's,
Standard & Poor's, Duff & Phelps, and Fitch - of a company's ability to repay
principal and interest on its debt obligations, principally bonds and commercial
paper. Obviously, investors in both bonds and stocks follow these ratings rather
closely as indicators of a company's investment quality. If the company's credit
ratings are not mentioned in their financial reporting, it's easy to obtain them
from the company's investor relations department

Pasted from <http://www.investopedia.com/university/ratios/debt/ratio1.asp>

Debt Ratios: Introduction

By Investopedia on February 25, 2009 A A A
Filed Under: Beginning Investor, Cash Flow Statement, Debt/Equity, Financial
Statements,Fundamental Analysis, Solvency, Solvency Ratio Fundamental
Analysis, Beginning Investor,Cash Flow Statement, Debt/Equity, Financial
Statements, Solvency, Solvency Ratio
By Richard Loth (Contact | Biography)

The third series of ratios in this tutorial are debt ratios. These ratios give users
a general idea of the company's overall debt load as well as its mix of equity
and debt. Debt ratios can be used to determine the overall level of financial risk
a company and its shareholders face. In general, the greater the amount of
debt held by a company the greater the financial risk of bankruptcy.

The next chapter of this Debt Ratios section (Overview of Debt) will give readers
a good idea of the different classifications of debt. While it is not mandatory in
understanding the individual debt ratios, it will give some background
information on the debt of a company. The ratios covered in this section include
the debt ratio, which is gives a general idea of a company's financial leverage as
does the debt-to-equity ratio. The capitalization ratiodetails the mix of debt and
equity while the interest coverage ratio and the cash flow to debt ratio show
how well a company can meet its obligations.

To find the data used in the examples in this section, please see the Securities
and Exchange Commission's website to view the 2005 Annual Statement of
Zimmer Holdings.

Debt Ratios: Debt-Equity Ratio

By Investopedia A A A
Filed Under: Beginning Investor, Cash Flow Statement, Debt/Equity, Financial
Statements,Fundamental Analysis, Solvency, Solvency Ratio Fundamental
Analysis, Beginning Investor,Cash Flow Statement, Debt/Equity, Financial
Statements, Solvency, Solvency Ratio
By Richard Loth (Contact | Biography)

The debt-equity ratio is another leverage ratio that compares a company's total
liabilities to its total shareholders' equity. This is a measurement of how much
suppliers, lenders, creditors and obligors have committed to the company
versus what the shareholders have committed.

To a large degree, the debt-equity ratio provides another vantage point on a

company's leverage position, in this case, comparing total liabilities to
shareholders' equity, as opposed to total assets in the debt ratio. Similar to the
debt ratio, a lower the percentage means that a company is using less leverage
and has a stronger equity position.

Formula:

Components:

As of December 31, 2005, with amounts expressed in millions, Zimmer Holdings

had total liabilities of $1,036.80 (balance sheet) and total shareholders' equity
of $4,682.80 (balance sheet). By dividing, the equation provides the company
with a relatively low percentage of leverage as measured by the debt-equity
ratio.

Variations:
A conservative variation of this ratio, which is seldom seen, involves reducing a
company's equity position by its intangible assets to arrive at a tangible equity,
or tangible net worth, figure. Companies with a large amount of
purchased goodwill form heavy acquisition activity can end up with a negative
equity position.

Commentary:
The debt-equity ratio appears frequently in investment literature. However, like
the debt ratio, this ratio is not a pure measurement of a company's debt
because it includes operational liabilities in total liabilities.

Nevertheless, this easy-to-calculate ratio provides a general indication of a

company's equity-liability relationship and is helpful to investors looking for a
quick take on a company's leverage. Generally, large, well-established
companies can push the liability component of their balance sheet structure to
higher percentages without getting into trouble.

The debt-equity ratio percentage provides a much more dramatic perspective

on a company's leverage position than the debt ratio percentage. For example,
IBM's debt ratio of 69% seems less onerous than its debt-equity ratio of 220%,
which means that creditors have more than twice as much money in the
company than equity holders (both ratios are for FY 2005).

Merck comes off a little better at 150%. These indicators are not atypical for
large companies with prime credit credentials. Relatively small companies, such
as Eagle Materials and Lincoln Electric, cannot command these high leverage
positions, which is reflected in their debt-equity ratio percentages (FY 2006 and
FY 2005) of 91% and 78%, respectively

Pasted from <http://www.investopedia.com/university/ratios/debt/ratio3.asp>

Debt Ratios: Capitalization Ratio

By Investopedia A A A
Filed Under: Beginning Investor, Cash Flow Statement, Debt/Equity, Financial
Statements,Fundamental Analysis, Solvency, Solvency Ratio Fundamental
Analysis, Beginning Investor,Cash Flow Statement, Debt/Equity, Financial
Statements, Solvency, Solvency Ratio
By Richard Loth (Contact | Biography)

The capitalization ratio measures the debt component of a company's capital

structure, or capitalization (i.e., the sum of long-term
debt liabilities and shareholders' equity) to support a company's operations and
growth.

Long-term debt is divided by the sum of long-term debt and shareholders'

equity. This ratio is considered to be one of the more meaningful of the "debt"
ratios - it delivers the key insight into a company's use of leverage.
There is no right amount of debt. Leverage varies according to industries, a
company's line of business and its stage of development. Nevertheless, common
sense tells us that low debt and high equity levels in the capitalization ratio
indicate investment quality.

Formula:

Components:

As of December 31, 2005, with amounts expressed in millions, Zimmer Holdings

had total long-term debt of $81.60 (balance sheet), and total long-term debt
and shareholders' equity (i.e., its capitalization) of $4,764.40 (balance sheet).
By dividing, the equation provides the company with a negligible percentage of
leverage as measured by the capitalization ratio.

Variations:
None

Commentary:
A company's capitalization (not to be confused with its market capitalization) is
the term used to describe the makeup of a company's permanent or long-term
capital, which consists of both long-term debt and shareholders' equity. A low
level of debt and a healthy proportion of equity in a company's capital structure
is an indication of financial fitness.

Prudent use of leverage (debt) increases the financial resources available to a

company for growth and expansion. It assumes that management can earn
more on borrowed funds than it pays in interest expense and fees on these
funds. However successful this formula may seem, it does require a company to
maintain a solid record of complying with its various borrowing commitments.

A company considered too highly leveraged (too much debt) may find its
freedom of action restricted by its creditors and/or have its profitability hurt by
high interest costs. Of course, the worst of all scenarios is having trouble
meeting operating and debt liabilities on time and surviving adverse economic
conditions. Lastly, a company in a highly competitive business, if hobbled by
high debt, will find its competitors taking advantage of its problems to grab
more market share.

As mentioned previously, the capitalization ratio is one of the more meaningful

debt ratios because it focuses on the relationship of debt liabilities as a
component of a company's total capital base, which is the capital raised by
shareholders and lenders.

The examples of IBM and Merck will illustrate this important perspective for
investors. As of FY 2005, IBM had a capitalization ratio of 32%, and Merck's was
22%. It is difficult to generalize on what a proper capitalization ratio should be,
but, on average, it appears that an indicator on either side of 35% is fairly
typical for larger companies. Obviously, Merck's low leverage is a significant
balance sheet strength considering its ongoing struggle with product liability
claims. Eagle Materials and Lincoln Electric have capitalization ratios (FY 2006
and FY 2005) of 30% and 20%, which most likely fall into the average and low
ratio range, respectively. Zimmer Holdings' 2% capitalization ratio needs no
further comment.

Pasted from <http://www.investopedia.com/university/ratios/debt/ratio4.asp>

Debt Ratios: Interest Coverage Ratio

By Investopedia A A A
Filed Under: Beginning Investor, Cash Flow Statement, Debt/Equity, Financial
Statements,Fundamental Analysis, Solvency, Solvency Ratio Fundamental
Analysis, Beginning Investor,Cash Flow Statement, Debt/Equity, Financial
Statements, Solvency, Solvency Ratio
By Richard Loth (Contact | Biography)

The interest coverage ratio is used to determine how easily a company can pay
interest expenses on outstanding debt. The ratio is calculated by dividing a
company's earnings before interest and taxes (EBIT) by the company's interest
expenses for the same period. The lower the ratio, the more the company is
burdened by debt expense. When a company's interest coverage ratio is only
1.5 or lower, its ability to meet interest expenses may be questionable.

Formula:

Components:

As of December 31, 2005, with amounts expressed in millions, Zimmer Holdings

had earnings before interest and taxes (operating income) of $1,055.00
(income statement), and total interest expense of $14.30 (income statement).
This equation provides the company with an extremely high margin of safety as
measured by the interest coverage ratio.

Variations:
None

Commentary:
The ability to stay current with interest payment obligations is absolutely critical
for a company as a going concern. While the non-payment of debt principal is a
seriously negative condition, a company finding itself in financial/operational
difficulties can stay alive for quite some time as long as it is able to service its
interest expenses.

In a more positive sense, prudent borrowing makes sense for most companies,
but the operative word here is "prudent." Interest expenses affect a company's
profitability, so thecost-benefit analysis dictates that borrowing money to fund a
company's assets has to have a positive effect. An ample interest coverage ratio
would be an indicator of this circumstance, as well as indicating substantial
additional debt capacity. Obviously, in this category of investment quality,
Zimmer Holdings would go to the head of the class.

Let's see how the interest coverage ratio works out for IBM, Merck, Eagle
Materials and Lincoln Electric: 57, 20, 39 and 20, respectively. By any standard,
all of these companies, as measured by their latest FY earnings performances,
have very high interest coverage ratios. It is worthwhile noting that this is one
of the reasons why companies like IBM and Merck have such large borrowings -
because in a word, they can. Creditors have a high comfort level with
companies that can easily service debt interest payments. Here again, Zimmer
Holdings, in this regard, is in an enviable position

Pasted from <http://www.investopedia.com/university/ratios/debt/ratio5.asp>

Debt Ratios: Cash Flow To Debt Ratio

By Investopedia A A A
Filed Under: Beginning Investor, Cash Flow Statement, Debt/Equity, Financial
Statements,Fundamental Analysis, Solvency, Solvency Ratio Fundamental
Analysis, Beginning Investor,Cash Flow Statement, Debt/Equity, Financial
Statements, Solvency, Solvency Ratio
By Richard Loth (Contact | Biography)

This coverage ratio compares a company's operating cash flow to its total debt,
which, for purposes of this ratio, is defined as the sum of short-term
borrowings, the current portion of long-term debt and long-term debt. This ratio
provides an indication of a company's ability to cover total debt with its yearly
cash flow from operations. The higher the percentage ratio, the better the
company's ability to carry its total debt.

Formula:

Components:

As of December 31, 2005, with amounts expressed in millions, Zimmer Holdings

had net cash provided by operating activities (operating cash flow as recorded
in the statement of cash flows) of $878.20 (cash flow statement), and total debt
of only $1,036.80 (balance sheet). By dividing, the equation provides the
company, in the Zimmer example, with a cash flow to debt ratio of about 85%.

Variations:
A more conservative cash flow figure calculation in the numerator would use a
company'sfree cash flow (operating cash flow minus the amount of cash used
for capital expenditures).

A more conservative total debt figure would include, in addition to short-term

borrowings, current portion of long-term debt, long-term debt, redeemable
preferred stock and two-thirds of the principal of non-cancel-able operating
leases.

Commentary:
In the case of Zimmer Holdings, their debt load is higher than their operating
cash flows, giving it a ratio of less than one, however the percentage (being
above 80%) is considered high. In this instance, this circumstance would
indicate that the company has ample capacity to cover it's debt expenses with
its operating cash flow.

Under more typical circumstances, a high double-digit percentage ratio would

be a sign of financial strength, while a low percentage ratio could be a negative
sign that indicates too much debt or weak cash flow generation. It is important
to investigate the larger factor behind a low ratio. To do this, compare the
company's current cash flow to debt ratio to its historic level in order to parse
out trends or warning signs.

More cash flow to debt relationships are evidenced in the financial positions of
IBM and Merck, which we'll use to illustrate this point. In the case of IBM, its FY
2005 operating cash amounted to $14.9 billion and its total debt, consisting of
short/current long-term debt and long-term debt was $22.6 billion. Thus, IBM
had a cash flow to debt ratio of 66%. Merck's numbers for FY 2005 were $7.6
billion for operating cash flow and $8.1 billion for total debt, resulting in a cash
flow to debt ratio of 94%.

If we refer back to the Capitalization Ratio page, we will see that Merck had a
relatively low level of leverage compared to its capital base. Thus, it is not
surprising that its cash flow to debt ratio is very high

Pasted from <http://www.investopedia.com/university/ratios/debt/ratio6.asp>

Financial Ratio Cheat Sheet

This is a summary of financial ratios commonly used in the evaluation of a company.
Liquidity ratios
1) Current Ratio = Current Asset / Current Liability
2) Quick Ratio = (Cash + Marketable securities + account receivables) / Current Liability
3) Cash Ratio = (Cash + Marketable securities)/current Liability
4) Cash flow from operations ratio =Cash Flow from Operations / Current Liability
5) Receivable Turnover = net annual sales / average receivables
6) Average Number of days receivables outstanding (Average Collection period) = 365/receivables
turnover
7) Inventory Turnover = Cost of goods sold (COGS) / average inventory
8) Average Number of days in stock = 365/ Inventory turn over
9) Payable Turnover = Annual Purchases / Average Payables
10) Average Number of days payables outstanding (Average age of payables) = 365 / payable turnover
11) Cash Conversion Cycle = Average collection period + average number of days in stock – average age
of payables

Profitability Ratios
1) Growth Profit Margin = gross profit / net sales
where gross profit = net sales – COGS
2) Operating Profit Margin = Operating Income / net sales
where Operating Income = Earnings before tax and interest (EBIT)
3) EBITDA margin = Earnings before interest, tax, depreciation and amortization / net sales
4) Net Margin (Profit Margin) = net income / sales
5) Contribution Margin = Contribution / sales
where contribution = sales – variable cost

Return on investment Ratios.

1) Return on Assets (ROA) = EBIT /average total assets
2) Return on common equity = (net income – preferred dividends)/average common equity
3) Return on Total equity (ROE) = net income / average total equity

Operating Efficiency Ratios

1) Total Asset turnover = net sales/average total assets
2) Fixed asset turnover = net sales / average net fixed assets
3) Equity turnover = net sales / average total equity

Financial Risk Ratios / Solvency Ratios

1) Debt to Total Capital = total debt / total capital
2) Debt to Equity = Total debt / total equity
3) Financial leverage = average total assets / average total equity
4) Interest Coverage Ratio = EBIT / interest expense
5) CFO to debt = Cash flow from operations / total debt
6) Fixed charge coverage = earnings before fixed charges and taxes / fixed charges

Valuation ratios
1) Price to earnings (P/E) ratio = current market price of the common stock / company earnings per
share
2) Earnings per share (EPS) = (net income – dividends on preferred stock) / weighted average number
of shares outstanding
3) Sustainable growth rate g = Retention rate * ROE
where retention rate = 1 – dividend declared /net income = 1 – dividend payout ratio

Pasted from <http://valuationacademy.com/financial-ratio-cheat-sheet/>

Asset management ratios

 — Accounts Payable Turnover Ratio
 — Asset Turnover
 — Capacity Utilization Rate
 — Cash Conversion Cycle (Operating Cycle)
 — Days Inventory Outstanding (DIO)
 — Days Payable Outstanding (DPO)
 — Days Sales Outstanding (DIO)
 — Defensive Interval Ratio (DIR)
 — Fixed Asset Turnover
 — Inventory Turnover
 — Receivable Turnover Ratio
Asset management ratios: What is it?
Asset management (turnover) ratios compare the assets of a company to its sales revenue.
Asset management ratios indicate how successfully a company is utilizing its assets to
generate revenues. Analysis of asset management ratios tells how efficiently and effectively a
company is using its assets in the generation of revenues. They indicate the ability of a
company to translate its assets into the sales. Asset management ratios are also known as
asset turnover ratios and asset efficiency ratios.
Asset management ratios are computed for different assets. Common examples of asset
turnover ratios include fixed asset turnover, inventory turnover, accounts payable turnover
ratio, accounts receivable turnover ratio, and cash conversion cycle. These ratios provide
important insights into different financial areas of the company and its highlights its strengths
and weaknesses.
High asset turnover ratios are desirable because they mean that the company is utilizing its
assets efficiently to produce sales. The higher the asset turnover ratios, the more sales the
company is generating from its assets.
Although higher asset turnover ratios are preferable, but what is considered to be high for one
industry, may be low for another. Therefore it is not useful to compare asset turnover ratios of
different industries. Different industries have different requirements with regard to assets. It
would be unwise to compare an ecommerce store which requires little assets to a
manufacturing organization which requires large manufacturing facilities, plant and equipment.
Low asset turnover ratios mean inefficient utilization of assets. Low asset turnover ratios mean
that the company is not managing its assets wisely. They may also indicate that the assets are
obsolete. Companies with low asset turnover ratios are likely to be operating below their full
capacity.
Financial analyses have highlighted relationship between profit margins and asset turnover
ratios. It has often been observed that companies with high profit margins have lower asset
turnover ratios. On the other hand, companies with lower profit margins tend to have higher
asset turnover ratios.
Asset turnover ratios are not always very useful. Asset turnover ratios will not give useful
insights into the asset management of companies which sell highly profitable products but not
often.

Accounts Payable Turnover Ratio

Accounts payable turnover ratio is an accounting liquidity metric that evaluates how fast a
company pays off its creditors (suppliers). The ratio shows how many times in a given period
(typically 1 year) a company pays its average accounts payable. An accounts payable turnover
ratio measures the number of times a company pays its suppliers during a specific accounting
period.

Read full text →

Asset Turnover
Asset turnover (total asset turnover) is a financial ratio that measures the efficiency of a
company's use of its assets to product sales. It is a measure of how efficiently management is
using the assets at its disposal to promote sales. The ratio helps to measure the productivity of
a company's assets.

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Capacity Utilization Rate
Capacity utilization rate is a metric which is used to compute the rate at which probable
output levels are being met or used. The output is displayed as a percentage and it can give a
proper insight into the general negligence that the organization is at a point of time. Capacity
utilization rate is also called as operating rate.

Read full text →

Cash Conversion Cycle (Operating Cycle)
The cash conversion cycle (CCC) is the length of time between a firm's purchase of
inventory and the receipt of cash from accounts receivable. It is the time required for a
business to turn purchases into cash receipts from customers. CCC represents the number of
days a firm's cash remains tied up within the operations of the business.

Read full text →

Days Inventory Outstanding (DIO)
Days Inventory Outstanding (DIO) is an average inventory level expressed in days.

Read full text →

Days Payable Outstanding (DPO)
Days payable outstanding (DPO) is the accounts payableturnover expressed in days
(accounts payable outstanding in days).

Read full text →

Days Sales Outstanding (DIO)
Days Sales Outstanding (DIO) is an average collection period in days for the accounts
receivable (accounts payable outstanding in days).

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Defensive Interval Ratio (DIR)
Defensive Interval Ratio is a ratio that measures the number of days a company can operate
without having access to non-current assets. This ratio compares the assets to the liabilities
instead of comparing assets to expenses. Defensive Interval Ratio or DIR is a good way to find
out if the company is a good investment for you or not. Defensive Interval Ratio is also called
as Defensive Interval Period.

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Fixed Asset Turnover
Fixed asset turnover ratio compares the sales revenue a company to its fixed assets. This
ratio tells us how effectively and efficiently a company is using its fixed assets to generate
revenues. This ratio indicates the productivity of fixed assets in generating revenues. If a
company has a high fixed asset turnover ratio, it shows that the company is efficient at
managing its fixed assets. Fixed assets are important because they usually represent the
largest component of total assets.

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Inventory Turnover
Inventory turnover is a measure of the number of times inventory is sold or used in a given
time period such as one year. It is a good indicator of inventory quality (whether the inventory
is obsolete or not), efficient buying practices, and inventory management. This ratio is
important because gross profit is earned each time inventory is turned over. Also called stock
turnover.

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Receivable Turnover Ratio
The receivable turnover ratio (debtors turnover ratio, accounts receivable turnover ratio)
indicates the velocity of a company's debt collection, the number of times average receivables
are turned over during a year. This ratio determines how quickly a company collects
outstanding cash balances from its customers during an accounting period. It is an important
 indicator of a company's financial and operational performance and can be used to determine
if a company is having difficulties collecting sales made on credit.

Read full text →

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Use Asset Management Ratios in Financial Ratio Analysis

Turnover Ratios Analyze the Firm's Efficiency in Generating Sales
By Rosemary Peavler
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Asset management ratios are the key to analyzing how effectively and efficiency your small business is managing its
assets to produce sales. Asset management ratios are also called turnover ratios or efficiency ratios. If you have too
much invested in your company's assets, your operating capital will be too high. If you don't have enough invested in
assets, you will lose sales and that will hurt your profitability, free cash flow, and stock price.
You, as the owner of your business, have the task of determining the right amount to invest in each of your asset
accounts. You do that by comparing your firm to other companies in your industry and see how much they have
invested in asset accounts. You also keep track of how much you have invested in your asset accounts from year to year
and see what works.
Inventory Turnover Ratio
The inventory turnover ratio is one of the most important asset management or turnover ratios. If your firm sales
physical products, it is the most important ratio. Inventory turnover is calculated as follows:
Inventory turnover ratio = Net sales/Inventory = ____X
This means that you divide net sales, from the income statement, from the inventory figure on the balance sheet and
you get a number that is a number of times. That number signifies the number of times inventory is sold and restocked
each year. If the number is high, you may be in danger of stockouts. If it is low, watch out for obsolete inventory.
Days' Sales in Inventory
The Days' Sales in Inventory ratio tells the business owner how many days, on average, it takes to sell inventory. The
usual rule is that the lower the DSI is, the better, since it is better to have inventory sell quickly than to have it sit on
your shelves.
If you know your company's inventory turnover ratio, you can quickly calculate the Days' Sales in Inventory ratio. This
quick formula for calculating this ratio is the following:
Days' Sales in Inventory = 365 days/Inventory turnover = ____ Days
If you don't have the inventory turnover ratio, there is another formula you can use to calculate Days' Sales in Inventory:
Days' Sales in Inventory = Inventory/Cost of Goods Sold X 365 = _____ Days
The value of your inventory will come from your latest balance sheet. The cost of goods sold is taken from the income
statement. This ratio measures the company's financial performance for both the owners and the managers as it
pertains to the turnover of inventory. Inventory turnover varies from industry to industry. Generally, a lower number of
days' sales in inventory is better than a higher number of days. It will vary from industry to industry.
Average Collection Period
Average collection period is also called Days' Sales Outstanding or Days' Sales in Receivables. It measures the number of
days it takes a company to collect its credit accounts from its customers. A lower number of days is better because this
means that the company gets its money more quickly. Average collection period varies from industry to industry,
however. It is important that a company compare its average collection period to other firms in its industry.
Here is the calculation for Average Collection Period:
365 days/Sales/Accounts Receivable = _____ Days
The sales figure comes from the income statement and the accounts receivable comes from the balance sheet.
 Receivables Turnover
Receivables turnover is a ratio that works hand in hand with average collection period to give the business owner a
complete picture of the state of the accounts receivable. Receivables turnover looks at how fast we collect on our sales
or, on average, how many times each year we clean up or totally collect our accounts receivable. The calculation is as
follows:
Receivables Turnover = Sales/Accounts Receivable = ____ times
Generally, the higher the receivables turnover, the better as it means you are collecting your credit accounts on a timely
basis. If your receivables turnover is low, you need to take a look at your credit and collections policy and be sure they
are on target.
Fixed Asset Turnover
The fixed asset turnover ratio looks at how efficiently the company uses its fixed assets, like plant and equipment, to
generate sales. If you can't use your fixed assets to generate sales, you are losing money because you have those fixed
assets. Property, plant, and equipment are expensive to buy and maintain. In order to be effective and efficient, those
assets must be used as well as possible to generate sales. The fixed asset turnover ratio is an important asset
management ratio because it helps the business owner measure the efficiency of the firm's plant and equipment.
Here is the calculation for fixed asset turnover:
Fixed Asset Turnover = Sales/Net Fixed Assets = _____ times
Usually, the higher the number of times, the better. However, if the ratio is too high, your equipment is probably
breaking down because you are operating over capacity. If the number of times is too low as compared to the industry
or to previous years of firm data, then your firm is not operating up to capacity and your plant and equipment is likely
sitting idle.
Net Working Capital Turnover
The net working capital turnover ratio is an asset management ratio that is a "big picture" ratio. It measures how hard
our working capital is "working" for the firm. Working capital is what you have left over after the company pays its
short-term debt obligations. Generally, the higher the value of the ratio, the better. The calculation is as follows:
Net Working Capital Turnover = Sales/Net Working Capital
Total Asset Turnover
The total asset turnover ratio is the asset management ratio that is the summary ratio for all the other asset
management ratios covered in this article. If there is a problem with inventory, receivables, working capital, or fixed
assets, it will show up in the total asset turnover ratio. The total asset turnover ratio shows how efficiently your assets,
in total, generate sales. The higher the total asset turnover ratio, the better and the more efficiently you use your asset
base to generate your sales. Here is the calculation:
Total Asset Turnover = Sales/Total Assets = _____ times
When you analyze your asset management ratios, you can look at your total asset turnover ratio and if there is a
problem, you can go back to your other asset management ratios and isolate the problem. Knowing your position
regarding the efficiency of using assets to make sales is crucial to the success of your firm

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analysis.htm>

Asset Management Ratios

16.11.1
Fixed Assets Turnover Ratio
Fixed-asset turnover is the ratio of sales to value of fixed assets, indicating how well the business
uses fixed assets to generate sales.

KEY POINTS
 Fixed asset turnover = Net sales / Average net fixed assets.
 The higher the ratio, the better, because a high ratio indicates the
business has less money tied up in fixed assets for each unit of currency
of sales revenue. A declining ratio may indicate that the business is
over-invested in plant, equipment, or other fixed assets.
 Fixed assets, also known as a non-current asset or as property, plant,
and equipment (PP&E), is a term used in accounting for assets and
property that cannot easily be converted into cash.

Fixed Assets
Fixed assets, also known as a non-current asset or as property, plant,
and equipment (PP&E), is a term used in accounting for assets and
property that cannot easily be converted into cash. This can be
compared with current assets, such as cash or bank accounts, which are
described as liquid assets. In most cases, only tangible assets are
referred to as fixed.
Moreover, a fixed/non-current asset also can be defined as an asset not
directly sold to a firm's consumers/end-users. As an example, a baking
firm's current assets would be its inventory (in this case, flour, yeast,
etc.), the value of sales owed to the firm via credit (i.e., debtors or
accounts receivable), cash held in the bank, etc. Its non-current assets
would be the oven used to bake bread, motor vehicles used to transport
deliveries, cash registers used to handle cash payments, etc. Each
aforementioned non-current asset is not sold directly to consumers.
These are items of value that the organization has bought and will use
for an extended period of time; fixed assets normally include items,
such as land and buildings, motor vehicles, furniture, office equipment,
computers, fixtures and fittings, and plant and machinery. These often
receive favorable tax treatment (depreciation allowance) over short-
term assets. According to International Accounting Standard (IAS) 16,
Fixed Assets are assets which have future economicbenefit that is
probable to flow into the entity and which have a cost that can be
measured reliably.
The primary objective of a business entity is to make a profit and
increase the wealth of its owners. In the attainment of this objective, it
is required that the management will exercise due care and diligence in
applying the basic accounting concept of “Matching Concept.” Matching
concept is simply matching the expenses of a period against the
revenues of the same period.
The use of assets in the generation of revenue is usually more than a
year–that is long term. It is, therefore, obligatory that in order to
accurately determine the net income or profit for a period depreciation,
it is charged on the total value of asset that contributed to the revenue
for the period in consideration and charge against the same revenue of
the same period. This is essential in the prudent reporting of the net
revenue for the entity in the period.
Fixed-asset Turnover
 Fixed-asset turnover is the ratio of sales (on the profit and loss account)
to the value of fixed assets (on the balance sheet). It indicates how well
the business is using its fixed assets to generate sales. Figure 1
Fixed asset turnover = Net sales / Average net fixed assets
Generally speaking, the higher the ratio, the better, because a high ratio
indicates the business has less money tied up in fixed assets for each
unit of currency of sales revenue. A declining ratio may indicate that the
business is over-invested in plant, equipment, or other fixed assets.

Financial Ratio Analysis: Metrics for Crucial Assessments

Financial ratio analysis converts raw data from financial statements into meaningful proportions or
percentages. Combined with other ratios, financial ratio analysis helps to paint a picture of a company’s
current position, as well as its potential. There are several categories of financial ratio analysis.

Short-Term Solvency Rates

The quick and current ratios belong to the short-term solvency ratios. The ratios take current asset and
divide by the current liabilities in order to forecast the ability to pay short-term obligations. The main
difference between the two is the removal of Inventory from the equation in the quick ratio (also known as
the acid-test ratio). The related current ratio (also known as the working capital ratio) includes Inventory as
a liquid asset. The ratios tell internal managers and investors how much money has on hand that is easily
liquidated in proportion to its debt obligations in the next year with anything over 1.0 being a red flag.

Asset Management Ratios

Asset management ratios are many, but include; receivables turnover, inventory turnover, and total assets
turnover. How a firm manages assets, aids in forecasting future direction, providing information on how
much Inventory plays into its short-term solvency. One way to calculate the inventory turnover is cost of
goods sold (market value) divided by inventory (averaged for seasonal fluctuations). For example, $720,000
in CoGS at market value divided by $60,000 in Average Inventory = 12 – meaning that Inventory is cycled
out each month. The higher the number, the more efficient at managing Inventory it is, the lower the
number the more Inventory sits and isn’t sold timely at top market value.

Debt Management Ratios

Proper debt management financial ratio analysis is never more crucial than during an economic downturn
and credit crunch. If a company can’t pay its obligations, it loses leverage and the situation only worsens as
their credit worthiness declines and their interest rates increase. Also known as the leverage ratio, the
equity multiplier examines the proportion to which a company is using debt vs. shareholder equity to finance
its assets and operations - a higher number (above 1.00) means too high of a reliance on debt. For
example, a company with 5.2 million in assets divided by the 11.3 million in shareholder equity the EQM is
.46.

Profitability Ratios
Profitability ratios incorporate the net income and provide a lot of information about the how income relates
to expenses. These include profit margin, return on assets, and return on equity. Profit margin is calculated
by taking the net income divided by sales. Profitability financial ratio analysis must be reviewed in context of
the industry standard and any possible cyclical issues. For example, Toys R Us does the majority of its
income during the holiday shopping months, so you would not want to compare 4th and 1st quarter
earnings against one another, though you would want to compare annual 4th quarter earnings.

Market Value Ratios

Price-earnings ratios such as the P/E ration and earnings per share ratio illustrate stock worth and may be
able to point to growth stocks for investors. P/E ratio is calculated by taking the price per share divided by
earnings per share. A high PE ratio indicates that investors expect the stock to rise and are willing to pay a
premium price for it. Earnings per share is calculated by taking net income divided by the number of shares
outstanding. EPS indicates past profit created per share, and must also be analyzed in context of its own
past performance with rising numbers indicating a possible growth stock.

Financial ratio analysis is a system of metrics that provide useful information about profitability, asset and
debt management. When reviewed within the industry standards and against relevant past performance,
financial ratio analysis provides extensive, calculable information in order to make strategy and investment
decisions.

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