Balance sheet efficiency ratios - Part 2
1. Balance sheet efficiency ratios - Part 2
We looked at the debtor days and days payable outstanding ratios in the previous lesson, and now we will look at more ratios to help us get a greater understanding of the financial position in order to build a good forecast.2. Days in inventory
In this chapter, we will cover an asset account called inventory. How a company manages their inventory is very important. Inventory costs money - a company makes a product and needs to store it somewhere until it is sold. Inventory can also become out of date or even expire and not be able to be sold, and this is something we do not want. However, if a company has no stock of inventory, they could lose out on a sale. If a customer does not want to wait until the company restocks, he could go to a competitor. So it is important to manage inventory levels well. We can have a look at the days in inventory ratio, or DII ratio, to tell us the number of days the company has inventory on hand before selling it. The formula is as follows: average inventory divided by the result of total COGS multiplied by number of days in the year. Again, this ratio is dependent on the industry and company, for example, a car company and a supermarket would have different inventory days that would be seen as normal for their industry.3. Asset turnover ratio
The final ratio we will look at is the asset turnover ratio. This is an interesting ratio, as it shows us the level of assets needed in order to make sales, or in other words, the level of assets compared to sales generated by the company, which is highly dependent on the industry. What does this mean? Well, let's have a look at the formula: sales divided by the total average assets. In a company that has a high amount of assets, for example, a company that owns production facilities, the ratio would probably be rather low, reflecting that a high investment in assets are needed to generate a profit. However, a tech startup might have fewer traditional assets and a higher asset turnover ratio, as the sales do not need a high investment in assets, for example, a tech start-up could be done from home, with no more investment than a laptop and internet connection. This is just an example to show you how to read the ratio. Again, the ratio should be used in comparison to industry averages and also in combination with other ratios.4. Let's practice!
Let's now practice a bit with these new ratios.Create Your Free Account
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