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Financial Ratios

See also:
Quick Ratio Analysis
Price to Book Value Analysis
Price Earnings Growth Ratio Analysis
Time Interest Earned Ratio Analysis

Use of Financial Ratios

Financial Ratios are used to measure financial performance against standards. Analysts compare financial ratios to industry averages (benchmarking), industry standards or rules of thumbs and against internal trends (trends analysis). The most useful comparison when performing financial ratio analysis is trend analysis. Financial ratios are derived from the three financial statements; Balance Sheet, Income Statement and Statement of Cash Flows.

Financial ratios are used in Flash Reports to measure and improve the financial performance of a company on a weekly basis.

Financial Ratio Categories

The following five (5) major financial ratio categories are included in this list.

  • Liquidity Ratios
  • Activity Ratios
  • Debt Ratios
  • Profitability Ratios
  • Market Ratios

Liquidity Ratios

Liquidity ratios measure whether there will be enough cash to pay vendors and creditors of the company. Some examples of liquidity ratios include the following:

Activity Ratios

Activity ratios measure how long it will take the company to turn assets into cash. Some examples of activity ratios include the following:

Debt Ratios

Debt ratios measure the ability of the company to pay its’ long term debt. Some examples of debt ratios include the following:

Profitability Ratios

The profitability ratios measure the profitability and efficiency in how the company deploys assets to generate a profit. Some examples of profitability ratios include the following:

Market Ratios

The market ratios measure the comparative value of the company in the marketplace. Some examples of market ratios include the following:

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Financial Ratios, Financial Ratio Categories, Use of Financial Ratios

Financial Ratios, Financial Ratio Categories, Use of Financial Ratios

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Improving Profitability – Fuel for Growth

How do you focus on improving profitability instead of just boosting sales? 2016 wasn’t the best year for some of us, but the new year provides a perfect opportunity to reassess goals. An entrepreneur’s natural tendency is to increase sales in order to balance out last year’s financials. But what many entrepreneurs fail to consider is are those sales actually profitable?

There’s Only So Much Cash

Why is improving profitability instead of simply increasing sales so important? Because, believe it or not, you can actually grow yourself into bankruptcy.

Huh?

Many are quick to say that more sales is the solution – however, there are a lot of factors you have to consider before you start selling everything. One of the most important metrics you must know is your cash conversion cycle. The cash conversion cycle is the length of time it takes a company to convert resource inputs into cash flows.

Cash Conversion Cycle Formula:

Cash Conversion Cycle (CCC) =Days Sales Outstanding (DSO) + Days Inventory Outstanding (DIO) – Days Payable Outstanding (DPO)

– or –

CCC = DSO + DIO – DPO

improving profitability instead of salesDaily Sales Outstanding (DSO): This metric measures the number of days it takes to convert your receivables into cash. Ideally, the faster you can collect, the faster you can use the cash to fuel growth.

Days Inventory Outstanding (DIO): This is an indicator of how quickly you can turn your inventory into cash. Reducing DIO is good. If all of your cash is tied up in inventory that isn’t moving, then you might have a problem.

Days Payable Outstanding (DPO): This measures how quickly you are paying your vendors. If you are consistently paying your vendors more quickly than you are getting paid by your customers, then you risk running out of cash. If your vendors aren’t giving you a discount for paying early, then why are you paying early? If you have 30 days to pay, then why pay on the second day? Use that cash for the other 28 days you have for other vendors who offer you discounts or to fuel growth.

Managing the cash conversion cycle is a key way you can enable your company to grow.  And we all know how fond entrepreneurs are of growth…

(Click here to learn How to be a Wingman and be the trusted advisor to your team.)

Cash is like Jet Fuel

Often, entrepreneurs (especially those from a sales background) focus on improving sales. What many fail to realize is you can actually sell yourself into bankruptcy.

Let’s compare a business to a jet. If a jet is moving at a constant pace, then the fuel used to power the jet runs out at a constant pace. From a business perspective, if the sales in a company are constant, then the cash and assets required to fuel the company is also constant and predictable.
improving profitability instead of salesHowever, if a company decides to increase sales, then this requires more “fuel” or cash.

But if an entrepreneur decides to increase sales to a greater degree than cash flow, almost vertically, then the business may run out of fuel (cash) and can ultimately crash and burn.
improving profitability instead of sales

The quicker you grow, the quicker you burn cash.

improving profitability instead of sales

Sustainability is Key

The sustainable growth rate of a company is a measure of how much a company can grow based upon its current return on assets. The sustainable growth rate of a company is like the wind turbine of a jet. Naturally, the wind turbine gives the jet a 5-10% incline. But what if you want to grow to 25%? Or 50%?

To grow faster than your return on assets, you’ll need to take on additional debt or seek equity financing. Either you pay for it, or someone else does. To avoid increasing debt or giving up control, it’s important to maximize your current asset velocity (think managing CCC) and make sure your sales are profitable.

(Be more than overhead. Be the wingman to your CEO by increasing cash flow!)

How to Grow Your Business

If you want to grow your business, there are a couple of things you can do:

(1) Increase your profitable sales. This means deciding which projects have the lowest risk, but highest reward for your business. Time is money, so which customers are worth your time? In exploring this, you might have to conduct some market research for your target market.

For example, if you have some customers who are slow to pay, they’re straining your liquidity. Although it may be difficult, you might have to fire some customers and focus your resources on customers that aren’t such a drain.

(2) Increase capital. Capital is the funding you need to grow the business. Capital can be an investment from an outsider, or it can be cash generated internally by increasing cash flows and maximizing profitability.

Internally: A company can increase cash flow by managing the cash conversion cycle. Collect your receivables faster and manage inventory levels and payables. It is a good idea for a company to grow as organically as possible, meaning growing cash internally.

Externally: If you’ve tightened up your CCC as much as possible, it might be necessary to look for outside sources of cash. However, having external sources of cash is a trade-off; you’ll have debt with a bank, and you might have to give up part of your company to investors (depending on the terms).

Conclusion

So when your business owner says, “let’s increase sales!”, remember focus on making profitable sales. Look at improving the Cash Conversion Cycle to make the most of your internal resources.  Consider outside financing when/if your existing return on assets won’t get you where you want to be.

Don’t crash and burn – make sure your company has the fuel it needs. Your business owner is looking to you to help them grow their business. To learn how to do it, access the free How to be a Wingman whitepaper here.

improving profitability

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Operating Cycle Definition

Operating Cycle Definition

The Operating cycle definition establishes how many days it takes to turn purchases of inventory into cash receipts from its eventual sale. It is also known as cash operating cycle, cash conversion cycle, or asset conversion cycle. Operating cycle has three components of payable turnover days, Inventory Turnover days and Accounts Receivable Turnover days. These come together to form the complete measurement of operating cycle days. The operating cycle formula and operating cycle analysis stems logically from these.

The payable turnover days are the period of time in which a company keeps track of how quickly they can pay off their financial obligations to suppliers. Inventory turnover is the ratio that indicates how many times a company sells and replaces their inventory over time. Usually, calculate this ratio by dividing the overall sales by the overall inventory. However, you can also calculate the ratio by dividing COGS by the average inventory. Finally, the accounts receivable turnover days is the period of time the company is evaluated on how fast they can receive payments for their sales. In conclusion, the operating cycle is complete when you put together all of these steps.


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Operating Cycle Applications

The operating cycle concept indicates a company’s true liquidity. By tracking the historical record of the operating cycle of a company and comparing it to its peers in the same industry, it gives investors investment quality of a company. A short company operating cycle is preferable. This is because a company realizes its profits quickly. Thus, it allows a company to quickly acquire cash to use for reinvestment. A long business operating cycle means it takes longer time for a company to turn purchases into cash through sales.

In general, the shorter the cycle, the better a company is. Tie up less time capital in the business process. In other words, it is in a business’ best interest to shorten the business cycle over time. Try to shorten each of the three cycle sections by a small amount. The aggregate change that comes from the shortening of these sections can create a significant change in the overall business cycle. Thus, it can consequently lead to a more successful business.

operating cycle definition

See Also:
Operating Cycle Analysis

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Raise Inventory Turnover Ratio

Raise or Increase Inventory Turnover Ratio

In order to increase inventory turnover ratio for a company, it is important to understand the calculations that go into calculating the turnover ratio. Once this is achieved, a company can go about the necessary efforts to raise this ratio, increasing the overall inventory sold.

Inventory Ratio Calculation

Inventory turnover ratio calculations may appear intimidating at first but are fairly easy once a person understands the key concepts of inventory turnover.

For example, assume annual credit sales are $10,000, and inventory is $5,000. The inventory turnover is: 10,000 / 5,000 = 2 times

For example, assume cost of goods sold during the period is $10,000 and average inventory is $5,000. Inventory turnover ratio: 10,000 / 5,000 = 2 times

This means that there would be 2 inventory turns per year. That is a company would take 6 months to sell and replace all inventories.

Inventory Turnover Ratio: Example

For example, Derek owns a retail clothing store which sells the best designer attire. Derek, an avid fan of fashion, has worked in the apparel industry for quite a while and is well suited for the operations of his company.

Still, Derek has a little to learn about the business of retail clothing. He has been studying the subject with passion and wants to grow his business. From his study he has realized that inventory turnover is the key to his business.

Derek first talks to his accountant for inventory turnover ratio analysis. This requires somewhat of an expert because the matter is more complicated than the abilities simple, web-based inventory turnover ratio calculator. His accountant comes up with a figure which Derek would like to increase.

Annual credit sales are $10,000 and inventory is $5,000

The inventory turnover is: 10,000 / 5,000 = 2 times

Derek decides, from this, that he needs to make some changes. He aligns a few strategies to move his products. First, he considers marking-down styles from the previous season as each season approaches. Similarly, he considers product give-aways with minimum transaction amounts. Derek considers the option of spreading contests and deals on social networking websites. He finishes his evaluation by finding ways to turn his extra inventory into a tax write-off.

Derek is pleased because he is applying his newly found skills and knowledge to better his business. Derek looks forward to the future.

increase inventory turnover ratio

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Access your Flash Report Execution Plan in SCFO Lab. The step-by-step plan to create a dashboard to measure productivity, profitability, and liquidity of your company.

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increase inventory turnover ratio

See Also:
Inventory Turnover Ratio Analysis

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Operating Cycle Definition

See Also:
Operating Cycle Analysis

Operating Cycle Definition

The Operating cycle definition establishes how many days it takes for a company to turn purchases of inventory into cash receipts from its eventual sale. It is also known as cash operating cycle or cash conversion cycle or asset conversion cycle. Operating cycle has three components of payable turnover days, Inventory Turnover days and Accounts Receivable Turnover days. These come together to form the complete measurement of operating cycle days. The operating cycle formula and operating cycle analysis stems logically from these. To be more specific, the payable turnover days are the period of time a company keeps track of how quickly they can pay off their financial obligations to suppliers.

The next step, inventory turnover, is the ratio that indicates how many times a company sells and replaces their inventory over time. Usually, calculate this ratio by taking the overall sales and dividing it by the overall inventory. However, calculate the ratio by dividing the cost of goods sold by the average inventory. The final step, the accounts receivable turnover days, encase the period of time in which the company is evaluated on how fast they can receive payments for their sales. As said before, when you put together all of these steps, the operating cycle is complete

Operating Cycle Applications

The operating cycle concept indicates a company’s true liquidity. By tracking the historical record of the operating cycle of a company and comparing it to its peer groups in the same industry, it gives investors investment quality of a company. A short company operating cycle is preferable since a company realizes its profits quickly. It also allows a company to quickly acquire cash to use for reinvestment. A long business operating cycle means it takes longer time for a company to turn purchases into cash through sales.

In general, the shorter the cycle, the better a company is. This is since less capital is tied up in the business process. In other words, it is in a business’ best interest to shorten the business cycle over time. The easiest way is to shorten each of the three cycle sections by, at least, a small amount. The aggregate change that comes from the shortening of these sections can create a significant change in the overall business cycle. As a result, it can consequently lead to a more successful business.

For more ways to add value to your company, download your free A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.

Operating Cycle Definition

Strategic CFO Lab Member Extra

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Click here to learn more about SCFO Labs

Operating Cycle Definition

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Operating Cycle Analysis

See Also:
Operating Cycle Definition
days inventory outstanding
Cash Cycle
day sales outstanding
days payable outstanding
Financial Ratios

Operating Cycle Formula

Complete operating cycle analysis calculations simply with the following formula:

Operating cycle = DIO + DSO – DPO

Where

DIO represents days inventory outstanding

DSO represents day sales outstanding

DPO represents days payable outstanding

Operating Cycle Calculation

Calculating operating cycle may seem daunting but results in extremely valuable information.

DIO = (Average inventories / cost of sales) * 365 DSO = (Average accounts receivables / net sales) * 365

DPO = (Average accounts payables / cost sales) * 365

For example, what is the operating cycle of a business? A company has 90 days in days inventory outstanding, 60 days in days sales outstanding and 70 in days payable outstanding. See the following calculation to see how to work it out:

Operating cycle = 90 + 60 – 70 = 80

In conclusion, it takes an average 80 days for a company to turn purchasing inventories into cash sales. In regards to accounting, operating cycles are essential to maintaining levels of cash necessary to survive. As a result, maintaining a beneficial net operating cycle ratio is a life or death matter.

Resources

If you want statistical information about industry financial ratios, then go to the following websites: www.bizstats.com and www.valueline.com.

For more ways to add value to your company, download your free A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.

Operating Cycle Analysis

Strategic CFO Lab Member Extra

Access your Projections Execution Plan in SCFO Lab. The step-by-step plan to get ahead of your cash flow.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

Operating Cycle Analysis

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Inventory Turnover Ratio Analysis

See Also:
Raise Inventory Turnover Ratio
Economic Order Quantity
LIFO vs FIFO
Financial Ratios
Days Inventory Outstanding

Inventory Turnover Ratio Analysis Definition

Inventory turnover ratio, defined as how many times the entire inventory of a company has been sold during an accounting period, is a major factor to success in any business that holds inventory. It shows how well a company manages its inventory levels and how frequently a company replenishes its inventory. In general, a higher inventory turnover is better because inventories are the least liquid form of asset. A Flash Report is a useful tool in measuring and managing inventory turns.

Inventory Turnover Ratio Analysis Explanation

Inventory turnover ratio explanations occur very simply through an illustration of high and low turnover ratios. Despite this, many businesses do not survive due to issues with inventory. A low inventory turnover ratio shows that a company may be overstocking or deficiencies in the product line or marketing effort. It is a sign of ineffective inventory management because inventory usually has a zero rate of return and high storage cost. Higher inventory turnover ratios are considered a positive indicator of effective inventory management. However, a higher inventory turnover ratio does not always mean better performance. It sometimes may indicate inadequate inventory level, which may result in decrease in sales.

Inventory Turnover Ratio Formula

The following inventory turnover ratio formulas are listed below:

Inventory turnover = Sales / Inventory Or Inventory Turnover = Cost of good sold / Average inventory


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Inventory Turnover Ratio Calculation

Inventory turnover ratio calculations may appear intimidating at first but are fairly easy once a person understands the key concepts of inventory turnover. For example, assume annual credit sales are $10,000, and inventory is $5,000. The inventory turnover is:

10,000 / 5,000 = 2 times

For example, assume cost of goods sold during the period is $10,000 and average inventory is $5,000.

Inventory turnover ratio: 10,000 / 5,000 = 2 times

This means that there would be 2 inventory turns per year. That is a company would take 6 months to sell and replace all inventories.

Inventory Turnover Ratio Analysis Example

For example, Derek owns a retail clothing store which sells the best designer attire.  Derek worked in the apparel industry for quite a while, thus is well suited for the operations of his company. Still, Derek has a little to learn about the business of retail clothing. He studied the subject with passion and wants to grow his business. From his study, he realized that inventory turnover is the key to his business. First, Derek talked to his accountant for inventory turnover ratio analysis. You need somewhat of an expert because the matter is more complicated than the abilities simple, web-based inventory turnover ratio calculator.

His accountant comes up with a figure which Derek would like to increase. Annual credit sales are $10,000 and inventory is $5,000. The inventory turnover is:

10,000 / 5,000 = 2 times

Derek decides, from this, that he needs to make some changes. So he aligns a few strategies to move his products. First, he considers marking-down styles from the previous season as each season approaches. Similarly, he considers product give-aways with minimum transaction amounts. Then Derek considers the option of spreading contests and deals on social networking websites. He then finishes his evaluation by finding ways to turn his extra inventory into a tax write-off. Derek applied his newly found skills and knowledge to better his business. As a result, Derek looks forward to the future.

Cash Tied Up In Inventory

When your cash is tied up in inventory, it is bad news for your company. Make it your goal to increase inventory turnover to free up cash. For more ways to improve your cash flow, download the free 25 Ways to Improve Cash Flow whitepaper.

 

inventory turnover ratio, inventory turnover ratio analysis
Strategic CFO Lab Member Extra

Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

inventory turnover ratio, inventory turnover ratio analysis

Resources

For statistical information about industry financial ratios, please go to the following websites: www.bizstats.com and www.valueline.com.

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