Operating Performance Ratios

Sales to Assets Ratio This ratio demonstrates how well the business is efficiently deploying assets of the business and using them to generate sales.
  • Sales:    What are Sales?
  • Total Assets:    What are Total Assets?
    Interpret Your Results
  • The bigger the ratio the better.
  • Think about this ratio in terms of dollars - e.g. the amount of sales in dollars earned for the dollar value of asset the business has to generate these sales.
  • Example: A ratio of 2.5 shows that the business is generating $2.50 in sales for each ($1) dollar of total assets.
  • A low ratio demonstrates the business's sales volume is not as high as the volume of assets in the business should be generating.
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  • Click Here - to see possible ways to improve this ratio
  • Sales to Assets
    Ratio:

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Return On Assets Ratio (ROA) This ratio demonstrates how efficiently the business is utilizing and deploying business assets to generate profits (not sales but overall operating profits).
  • Pretax Profit:    What is Pretax Profit?
  • Total Assets:    What are Total Assets?
    Interpret Your Results
  • Shows the percentage of profits earned for each dollar of assets in the business.
  • Example: A ratio of 25% would show the business is earning $0.25 in pretax or operating profit for each $1 of assets in the business.
  • Management's main task in any business is to employ all the assets in the business in the most efficient manner to generate the greatest profits. The bigger this ratio, the better for the business.
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  • Return on Assets
    Ratio:

    %
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Return On Equity Ratio (ROE) This ratio demonstrates how efficiently the business is utilizing and deploying the equity, either invested in the business or generated by the business, to generate profits.
  • Pretax Profit:    What is Pretax Profit?
  • Equity:    What is Equity?
    Interpret Your Results
  • Shows the percentage of profits earned for each dollar of equity in the business. This is essentially the return for the money and time business owners and their investors have invested in the business.
  • Example: A ratio of 15% would show the business is earning $0.15 in pretax or operating profit for each $1 of equity employed in the business.
  • This ratio should be compared to similar business or to averages in the industry. Further, this ratio should be calculated over time to see which way, if any, it is trending. The higher the better.
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  • Return on Equity
    Ratio:

    %
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Inventory Turnover Ratio This ratio demonstrates how efficiently the business is using inventory (or raw materials) in the production cycles. Having to much inventory can be expensive to the business in carry costs (cost to hold and manage that excess inventory), spoilage (not being able to use some inventory or having it become obsolete before being utilized) or interest if it has been financed, etc., etc.
If your business does not have inventory - skip this ratio!
  • Cost of Goods Sold:    What is Cost of Goods Sold?
  • Inventory:    What is Inventory?
  • Days in Period:    What is Days in Period?
    Interpret Your Results
  • The Inventory Turnover Ratio shows the number of times the business's inventory is depleted and needs to be replaced during the period in question.
  • Example, a ratio of 5 designates that inventory is turning over 5 times per period or every 73 days (if the period of Costs of Goods in question is one year or 365 days).
  • The lower the number, the better for the business as it is turning over inventory into sales (the goal) as fast as possible.
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  • Inventory Turn
    Ratio:

  • Inventory Turn
    Days:


Accounts Receivable Turnover Ratio This ratio demonstrates how efficiently the business is managing and controlling its accounts receivables. Accounts receivables are sales that have not turned into cash yet. The faster the business can get cash for these sales, the faster it can pay its bills and realize its profit. Holding accounts receivables is essentially providing free credit to your customers and if not managed properly can adversely effect operations and profits.
  • Sales:    What is Cost of Goods Sold?
  • Accounts Receivables:    What are Accounts Receivables?
  • Days in Period:    What is Days in Period?
    Interpret Your Results
  • The quicker the business can turn accounts receivables into cash, the better for the business. Thus, the larger the ratio, the faster accounts receivables are being collected.
  • Example, a ratio of 5 designates that receivables are turning over 5 times per period or every 73 days (if the period of Sales in question is one year or 365 days).
  • If the business has bought inventory, worked to turn it into a finished product, sold that product but has yet to receive cash for that sale, it is essentially out the money for the inventory, productions and sales until it gets paid. But, it still has to pay for those goods, production and sales expenses.
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  • Receivable Turn
    Ratio:

  • Receivable Turn
    Days:

Accounts Payable Turnover Ratio This ratio demonstrates how efficiently the business is managing and paying its bills. Businesses want to take as much time as they can to pay bills as these payments are essentially taking cash flow out of the business. However, this should never be done if it costs the business to do so - e.g. late payment fees or added interest.
  • Cost of Goods Sold:    What is Cost of Goods Sold?
  • Accounts Payable:    What are Accounts Payable?
  • Days in Period:    What is Days in Period?
    Interpret Your Results
  • The slower the business can pay its obligations without penalty, the better for the business as more cash stays in the company longer - cash which can be used to generate more business, sales or profits. Thus, the smaller the ratio, the slower cash is leaving the business - providing more time to convert those assets, purchased by these payables, to generate more revenue for the business.
  • Example, a ratio of 5 designates that obligations (payables) are being paid 5 times per period or every 73 days (if the period of the Cost of Goods in question is one year or 365 days).
  • The longer cash can be held in the business, the better for the business.
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  • Payable Turn
    Ratio:

  • Payable Turn
    Days:

Ways to Improve: Sales to Assets Ratio: Two ways to improve this ratio. 1) Better deploy the assets in the business to generate more sales. 2) If increasing sales is not possible, reduce the volume of assets to the bare minimum or the business will be carrying assets that it is not using properly or adequately (another unnecessary expense).

- Back to Sales to Assets Ratio -

Return on Assets Ratio: Following the Sales to Asset Ratio above, the business should either increase sales (keeping all other expenses constant) or reduce or sell off any under performing assets. Additionally, the business could also seek to reduce any and all expenses to their bare minimum - to include reducing variable costs (cost of goods sold) or fixed costs (overhead or operating expenses).

- Back to Return on Assets Ratio -

Return on Equity Ratio: A low ratio demonstrates the business is not utilizing the equity in the business to its fullest. Improving this ratio, can consist of increasing sales (keeping all else the same), reducing all expenses (where possible) or reducing the amount of equity invested in the business. The goal is to get the most return on any investment injected into the business as this injection is usually the most expenses (most give up a portion of the business to investors of outside equity - or if owner's equity, it could have been deployed in other investments earning larger returns). To that note, this ratio should also be compared to other similar risk investments to determine if the return on the equity placed in the business is being utilized properly. Example, if similar investment are generating 30% in returns and your business is only generating 20% in returns, these funds (equity) would be better off in the other investment - unless the business can start generating 30% or better returns.

- Back to Return on Equity Ratio -

Inventory Turnover Ratio: Holding inventory can be expensive for the business due to carry costs (cost to hold and manage that excess inventory), spoilage (not being able to use some inventory or having it become obsolete before being utilized) or interest if it has been financed, etc., etc. The goal is to take in inventory right when it is needed and turn that inventory into revenue as soon as possible. To improve this ratio, the business could increase sales (keeping all else the same) or work on new efficiencies in production and sales to get the inventory converted into revenue much sooner. However, the main focus of the business should be to work on reducing excess inventory (at all stages of production) creating more of a just-in-time system to reduce the cost and carry of inventory.

- Back to Inventory Turnover Ratio -

Accounts Receivable Turnover Ratio: Allowing your customers extended time to pay is essentially providing them free credit. If customers fail to pay or take their time in paying, it could cost the business in bad debt expenses or, if the inventory to create the goods or the labor for the services was financed, in high interest expense - all of which hurts business profits. To improve this ratio, collect from customers as soon as possible or,
  • Increase sales while maintaining both inventory and accounts receivables levels.
  • Maintain sales while reducing both inventory and accounts receivable levels - this could also mean generating more payments from sales in cash.
- Back to Accounts Receivable Turnover Ratio -

Accounts Payable Turnover Ratio: To improve this ratio, either constantly negotiate with supplier and venders to extend the time the business has to pay these obligations without penalty or implement a sound payment system in which these obligations are paid exactly when due and not a moment before - taking advantage of any and all grace or payment periods.

Solid financial management consists of matching accounts receivables days with accounts payable days. Meaning that the business is collecting from customers at the same point or time frame that its bills (payables are due). But, to accumulate cash in the business or increase profits, great financial management consists of collecting receivable much faster than payables are due.

- Back to Accounts Payable Turnover Ratio -

Other financial ratio calculations you may want to evaluate:

Disclaimer: These ratios are for education purposes only and are in no way an adequate substitute for a professional financial advisor.

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Financial Ratios - Operating Performance