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Financial Statement Analysis - Operating Efficiency and Profitability Ratios

finance

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ankit.biswas.2024
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20 views13 pages

Financial Statement Analysis - Operating Efficiency and Profitability Ratios

finance

Uploaded by

ankit.biswas.2024
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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OPERATING EFFICIENCY

RATIOS
How well you are using your
resources to generate sales?
Operating Efficiency Ratios –
Inventory Turnover Ratio

AVERAGE INVENTORY = (Opening Inventory + Closing Inventory)/2

Broad Interpretation:
• Indicates how much inventory is needed by the firm to attain current level of
operations
• Higher ratio indicates lesser inventory used to achieve higher sales which is
a signal of efficient utilization of inventory
Operating Efficiency Ratios –
Inventory Holding Period

Broad Interpretation:
• A derivative of inventory turnover ratio which indicates the number of days
for which the firm keeps its inventory
• Higher ratio indicates lesser holding duration for inventory which in turn
results in lesser investment in inventory and hence efficient utilization of
resources.
Operating Efficiency Ratios –
Receivables Turnover Ratio

AVERAGE A/R = (Opening A/R+ Closing A/R)/2

Broad Interpretation:
• Indicates the average number of times amount is realized from credit sales
during an year
• Higher ratio indicates quick and efficient collection which results in lesser
investment in working capital and hence better funds management
• Extremely high ratio in comparison to competitors can drive away the
customers and result in decline in sales
Operating Efficiency Ratios –
Average Collection Period

Broad Interpretation:
• Indicates the average number of days in which our customers clear their dues.
• Lesser period indicates quick and efficient collection which results in lesser
investment in working capital and hence better funds management
• Extremely less period in comparison to competitors can drive away the
customers and result in decline in sales
Operating Efficiency Ratios –
Asset Turnover Ratio

AVERAGE Total Assets = (Opening TA+ Closing TA)/2

Broad Interpretation:
• Indicates how the assets are being utilized to achieve the present levels of
revenue from operations.
• Higher ratio indicates better utilization of assets as lesser assets are
generating higher level of sales
PROFITABILITY RATIOS

How well your Sales is


converting into bottom line?
Profitability Ratios – Net Profit
Margin

Broad Interpretation:
• The over all profitability criteria. Higher the ratio, better it is.
• The quality of the result depends upon the extraordinary gains/ losses
impacting the PAT
• Should be used along with Operating Profit Margin (discussed later)
Profitability Ratios – Operating
Profit Margin

Broad Interpretation:
• Indicator of efficiency in day to day and core operations of an entity.
• Higher the ratio better it is
• Must be evaluated along with Cash Realization ratio (discussed later) as it is
possible that company is producing high operating margin but cash from
operations is low (due to higher credit sales/ high inventory buildup)
Profitability Ratios – Cash
Profit Margin

Broad Interpretation:
• Measures profits earned in cash. Higher the ratio better it is.
• Would negate both non-operating and non-cash items to give a cash margin
generation capacity of the business
Profitability Ratios – Return on
Equity

Average Shareholders’ Funds (Equity)= (Opening SHF+


Closing SHF)/2

Broad Interpretation:
• Indicates how the company has returned on the funds provided by the
shareholders.
• This is a major variable which is considered by an investor to find out what
her investment will earn or likely to earn in a business
• It is same as asking for what rate of interest is bank offering on a FD when
one goes to make a FD in a bank
Profitability Ratios – Return on
Capital Employed

Average Capital Employed = Opening (SHF+NCL) + Closing (SHF+NCL)


2
SHF: Shareholders’ Fund (Equity) | NCL: Non-Current Liabilities

Broad Interpretation:
• Indicator of level of profits earned vis-à-vis total long-term funds employed
in the business
• Higher ratio indicates better utilization of funds invested in business
• A business must return adequately in context of sales (Net Profit Margin) as
well as funds deployed in business (Return on Capital Employed)
Profitability Ratios – Return on
Assets

AVERAGE Total Assets = (Opening TA+ Closing TA)/2

Broad Interpretation:
• Indicator of appropriateness of profits with respect to assets employed in
business
• A lower ratio indicates improper utilization of assets to generate profits

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