How to Find and Calculate Key Turnover Ratios

Turnover ratios reveal a company’s operational efficiency, showing how effectively it utilizes assets or manages liabilities. These ratios indicate how quickly assets are converted into sales or how often they are “turned over” within a period. They assess a business’s ability to generate revenue from its resources.

Essential Data for Turnover Ratios

Calculating turnover ratios relies on financial information from a company’s financial statements. The two key statements are the Income Statement, which reports financial performance over a period, and the Balance Sheet, which provides a snapshot of assets, liabilities, and equity at a specific point in time.

Several data points are needed for common turnover ratios. Sales or Revenue, representing total income from primary operations, is found on the Income Statement. Cost of Goods Sold (COGS), which includes direct costs for goods sold, also appears on the Income Statement.

Balance Sheet items like Inventory, Accounts Receivable, and Total Assets are also used. Inventory includes all goods held for sale. Accounts Receivable represents money owed by customers for credit sales. Total Assets reflect everything a company owns that has value. These items are found under the assets section of the Balance Sheet.

When using Balance Sheet figures for turnover ratios, “average” figures should be used. This involves taking the sum of beginning and ending balances for a period and dividing by two. Average figures help align Balance Sheet data with Income Statement data, providing a more accurate representation of activity over time.

Calculating Specific Turnover Ratios

With financial data gathered, turnover ratios can be calculated to assess a company’s efficiency. These calculations provide insights into different aspects of a business’s operations.

The Inventory Turnover Ratio measures how many times a company has sold and replaced its inventory over a specific period. The formula for this ratio is the Cost of Goods Sold divided by the Average Inventory. For example, if a company had a Cost of Goods Sold of $400,000 and its Average Inventory was $50,000, the Inventory Turnover Ratio would be 8 ($400,000 / $50,000). This indicates that the company sold and replenished its entire inventory 8 times during the period.

The Accounts Receivable Turnover Ratio indicates how efficiently a company collects the money owed to it by customers. This ratio is calculated by dividing Net Credit Sales by the Average Accounts Receivable. If a company’s Net Credit Sales were $750,000 and its Average Accounts Receivable was $60,000, the Accounts Receivable Turnover Ratio would be 12.5 ($750,000 / $60,000). This means the company collected its average accounts receivable 12.5 times during the period.

The Asset Turnover Ratio assesses how effectively a company uses its assets to generate sales. The formula for this ratio is Net Sales divided by Average Total Assets. For instance, if a company reported Net Sales of $1,500,000 and its Average Total Assets were $750,000, the Asset Turnover Ratio would be 2 ($1,500,000 / $750,000). This shows that for every dollar in assets, the company generated $2 in sales.

Making Sense of Your Results

Interpreting turnover ratio results provides insights into a company’s operational performance. These ratios illuminate how efficiently a business utilizes its resources.

For the Inventory Turnover Ratio, a higher result suggests strong sales and efficient inventory management, indicating inventory is selling quickly. Conversely, a lower ratio might signal weak sales, overstocking, or inventory management issues, suggesting goods are not moving rapidly.

A higher Accounts Receivable Turnover Ratio implies a company efficiently collects outstanding payments from customers. This indicates effective credit policies and collection processes, leading to quicker conversion of credit sales into cash. A lower ratio can suggest collection inefficiencies, lenient credit terms, or customers taking longer to pay debts.

For the Asset Turnover Ratio, a higher result indicates a company efficiently uses its assets to generate sales. This means the business produces more revenue for each dollar invested in assets. A lower ratio suggests the company may not be utilizing assets effectively to produce sales, potentially indicating underutilized capacity or inefficient resource allocation.