Operating Ratios, often referred to as Activity or Management Ratios, can provide an indication of both the efficiency of a company’s operations and the capability of management. These metrics are also known as Asset Management Ratios, as they demonstrate how effectively resources are being utilised.
Some of the popular Operating Ratios are:
By combining the data from the Profit and Loss Statement and Balance Sheet, we can analyse the ratios for ARBL.
To accurately gauge a company’s operating ratios, one must compare against its peers or assess the same company’s progress over time.
Fixed Assets Turnover
The ratio serves as an indicator of the amount of money brought in relative to the capital invested in fixed assets. This includes things such as equipment, buildings and other property. A higher ratio suggests that these resources are being utilised proficiently.
Operating Revenues / Total Average Asset = Fixed Assets Turnover
The assets considered while computing the fixed assets turnover should be net of accumulated depreciation, otherwise referred to as the company’s net block. We also include capital work in progress. Moreover, we use the average assets based on the arguments discussed in the previous chapter.
From ARBL’s FY14 Balance Sheet:
= (767.864 + 461.847)/2
= Rs.614.855 Crs
Given that the operating revenue for FY14 amounts to Rs.3436.7 Crs, the Fixed Asset Turnover ratio can be calculated.
= 3436.7 / 614.85
When assessing this ratio, factor in the company’s stage of development. An established business may not use its cash to purchase fixed assets; however, an expanding organisation may do so, which could result in a growing value of Fixed assets. ARBL is a good example, as their total for FY13 was Rs 461.8 Crs, and by FY14, it had grown to Rs 767.8 Crs.
This proportion is generally employed by those companies who need to invest a lot of capital to determine the success in the utilisation of their fixed assets.
Working Capital Turnover
Working capital is capital necessary to conduct the day to day operations of a company. It requires certain types of assets in order to do this, such as inventories, receivables and cash which are classified as current assets. An efficiently managed business would finance these through current liabilities and the difference between them gives us the working capital.
Current Assets – Current Liabilities = Working Capital
If the working capital is in the black, the business can readily manage its transactions. Conversely, if the figure is in the red, it typically necessitates a loan from their bank to make up for the shortfall.
The concept of ‘Working Capital Management’ is a major part of Corporate Finance. It involves inventory, cash and debtor’s management, all of which the CFO must effectively manage for the company. But for now, we will move on from this to focus on our main topic.
The working capital turnover ratio, also known as Net sales to working capital, is a measure that signifies how much income an organization produces for each unit of working capital. For instance, if the ratio is 4 then it means the company obtains an amount of Rs.4 from every Rs.1 worth of working capital. Clearly, better results are obtained when the number is higher. When establishing these results, one should always cross-check them with corresponding statistics from competitors in the same market and compare them to prior and projected numbers for a more thorough assessment of performance.
To determine the Working Capital Turnover, we utilise the formula:
Revenue divided by Average Working Capital.
Let’s apply this calculation to ARBL.
First, we need to calculate the working capital for FY13 and FY14 and find the average. The current assets (highlighted in red) and current liabilities (highlighted in green) for both years are indicated in the snapshot of ARBL’s Balance sheet provided.
The average working capital for the two financial years can be calculated as follows:
By utilising ARBL’s operational revenue of Rs.3437 Crs, we ascertain a working capital turnover ratio.
= 3437 / 672.78
= 5.11 times
The ratio of Rs.5.11 to every Rs.1 of working capital suggests that the company is performing well in terms of generating revenue for each unit of capital employed. Generally, the higher this value, the more effectively funds are being utilised to generate sales.