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In our day-to-day life, we often use the term unicorn to refer to a mythical horse-like creature. In the year 2013, a venture capital investor named Aileen Lee borrowed the term to describe a particular kind of startup company. The unicorn term was used to describe the startup companies which were thought to be so […]
Vulture Funds: The Name Says It All
What Do Vulture Funds Do ? Countries and companies are in turmoil all the time. When entities are close to financial distress, the normal tendency of investors is to flee. Common investors think that no more money can be made when an asset is about to hit rock bottom. This is not the case with […]
Automated Intercompany Loans
Liquidity management can be a big problem for several companies. This is particularly true if the company has a large number of subsidiaries that are scattered in different places around the world. Companies that grow via the mergers and acquisitions route tend to face this problem more than other companies. This is because they often […]
How are Organizational Aspects of Sports Leagues Linked to Finance
There are various types of sporting leagues across the world. These leagues cater to different sports in different parts of the world and are very different from one another. However, when it comes to certain organizational aspects of sports leagues, there is a high level of similarity between some leagues. These leagues are arranged in […]
Treasury Management Services
The role of commercial banks is to act as trusted partners to their corporate associates. Over the years, the degree of trust has been steadily increasing. As a result, many corporations across the world are outsourcing critical parts of their business to banks. In the previous articles, we have already seen how certain payment functions […]
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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