Business — Banking — Management — Marketing & Sales

Accounts Receivable Turnover Ratio

The Accounts Receivable Turnover Ratio indicates how many times, on average, the receivables revolve, that is, are generated and collected during the year. The receivables turnover ratio is computed as follows:

* — the sales figure used in computing the ratio should be that of credit sales only, because cash sales obviously do not generate receivables.

While the turnover figure furnishes a sense of the speed of collections and is valuable for comparison purposes, it is not directly comparable to the terms of trade that the enterprise normally extends. Such comparison is best made by converting the turnover into days of sales tied up in inventories. This measure, also known as Days Sales in Accounts Receivable, measures the number of days it takes, on average, to collect accounts receivable, which is calculated as follows:

These indicators are analyzed:

— In dynamics;

— Are compared to industry averages;

— Are compared to the credit terms granted by the enterprise.

If the company provides a 30 days period of sales on credit, then an average collection period of 60 days reflects either some or all of the following conditions:

A poor collection job (Marketing Department);

Customers in financial difficulty, or an excessive delinquency of 2 — 3 clients;

Introduction of new products (promotion phase);

A desire to make more sales in order to utilize available excess capacity;

Special competitive conditions in the industry.

The further analysis is directed towards the ageing schedule of accounts receivable for each customer.

Inventory Turnover Ratio

In most businesses, a certain level of inventory must be kept in order to generate an adequate level of sales. Inventories are normally considered the least liquid and at the same time the most risky component of the current assets group.

The Inventory Turnover Ratio measures the average rate of speed with which inventories move through and out of the enterprise. The computation of the Average Inventory Turnover is as follows:

Another measure of Inventory Turnover is also useful in assessing purchasing policy is te required number of Days to Sell Inventory. The computation of it is:

These indicators are analyzed:

— In dynamics;

— Are compared to industry averages;

— The further in-depth analysis is directed to the groups of inventories (raw materials, perishable tools, work in progress, finished goods).

A rate of return that is slower than that experienced historically, or that is below that normal in the industry, would lead to the preliminary conclusion that:

Inventories include items that are slow moving because they are obsolete, in weak demand, or otherwise unsalable;

A build-up of inventory in accordance wit a future contractual commitment, or for any number of other reasons that must be probed further;

Anticipation of a price rise;

One should never lose sight of the fact that the total inventory turnover ratio is an aggregate of widely varying turnover rates of individual components. Departmental or divisional turnover rates can similarly lead to more useful conclusions regarding inventory quality.

Accounts Payable Ratio

Not all liabilities represent equally urgent and forceful calls for payment. The nature of current liabilities must be judged in the light of the degree of urgency of payment that attaches to them.

The Accounts Payable Ratio indicates how many times the current liabilities are renewed within a certain period of time and it is expressed through the following formula:

A measure of the degree to which accounts payable represent current rather than overdue obligations can be obtained by calculating the Days Purchases in Accounts Payable Ratio:

The amount of Purchases is calculated based on the following relation:

* — Adjusting of Cost of Goods Sold figure for depreciation and other noncash-requiring charges, as well as for charges in inventories.

Tagged as: financial analysis