The Pitfalls of Overvaluation
It is often believed that the role of the investment banker is to sell the company for the highest price. The conventional belief is that the higher the price, the more successful the issue has been. However, over the years, the management of issuing companies, as well as investment bankers, have painfully discovered that a […]
Examples of Exchange Traded Derivatives
In the previous article, we studied about exchange traded derivatives. We studied their defining features and found out the reason behind their popularity. However, exchange traded derivatives are of many types. They are traded all over the world in different stock exchanges. Hence, there are many different types of exchange traded derivatives. In this article, […]
The War on Cash
Governments all over the world are fighting a war on cash. It is a known fact that the governments do not like cash. However, what is not clearly known is the reason behind it. What is it that makes governments all over the world unanimously abhor cash and pass legislation to control or even curb […]
Factors Impacting the Valuation of a Sports Franchise
Sports franchises are also business entities just like other private companies. Hence, it is possible for the owners of these companies to want to sell their stake just like other companies do. If the owner does want to sell off their stake, they need to know its valuation. Also, the valuation of different clubs can […]
Role of Social Media in The Silicon Valley Bank Run
Bank runs have been part of the banking industry for a long time. This is an unintended consequence of the fractional reserve banking system which is followed by the banking industry across the globe. Bank runs were common during the 1920s when the Great Depression took place. However, with the passage of time, the banking […]
Turnover ratios (also known as efficiency ratios) are a very important class of ratios. These ratios are not only used by financial personnel but also by the people in charge of operations. However, we are going to consider these ratios from the point of view of outside investors. This is because judgments have to be made about the efficiency of the firm based on limited information at hand. Here is an elementary introduction to what turnover ratios are and why they are important.
Over the years, investors have realized one rule and that is “Efficiency means growing business”. Any firm which is more efficient than its peers in producing the same goods and services will be more profitable in the short run. This profitability will allow the firm to build a competitive moat around itself and these businesses often become very valuable. This is like an investors dream formula for success. It is for this reason that investors carefully look at the efficiency numbers of newbie firms.
Finding out whether the firm is efficient is difficult even for a manager or an employee who has all the information at hand. Investors on the other hand just have the financial statements. They have to use these financial statements as their window into the operations of the firm. This is possible because every activity done by the firm involves costs and therefore leaves a trail on the financial statements. The turnover ratios are the investors’ method to connect the dots. They use information which is available in different financial statements. They then aggregate this information together and make meaningful conclusions about the operations of the company.
Turnover ratios as the name suggest, are related to sales. The logic is that given a certain amount of assets, how much sales can a company achieve? Therefore turnover ratios are always a comparison between an income statement item i.e. sales and the corresponding balance sheet item. For example if we compare fixed assets to sales, we get fixed asset turnover ratio. On the other hand when we compare accounts receivable to sales we get accounts receivable turnover ratio.
In case of inventory turnover ratio we use the COGS figure listed on the income statement rather than the sales figure. This is because inventory is reported at the cost price.
In conclusion, turnover ratios provide early clues to the efficiency of a firm. This can go a long way in making a successful investment and therefore an investor must learn how to use these ratios to his/her advantage.
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