Fundamental Principles of Pension Fund Risk Management
Pension funds are amongst the most heavily supervised financial instruments in the world. This is because of the fact that these funds hold the retirement funds of a large number of people. This means that the risk management practices at a pension fund have to be top-notch. The inability to manage risks can cost the […]
Accounting for Convertible Debt
In the previous article, we have established the fact that convertible debt is advantageous to some types of companies. We also know that this financial instrument can be quite complex. It is a known fact that investors who are not well versed in investing in bonds have a hard time understanding the functioning of convertible […]
Asset-Backed Commercial Paper
In the previous articles, we have already read about commercial papers and why they are an important segment of the money market. In most cases discussed earlier, commercial papers were related to unsecured debt. However, this need not always be the case. It is possible for commercial paper to be backed by other securities or […]
Common Restrictive Covenants in Fixed Income Securities
It is important for investors investing in fixed-income securities to be aware of restrictive covenants. This is because restrictive covenants can have a huge negative impact on the valuation as well as the liquidity of the debt. Bond indentures are detailed legal documents that can have many covenants which prove to be restrictive. However, there […]
What is Financial Modeling and What Purpose does it serve in the BFSI Sector?
What is Financial Modeling and How Does it Help Financial Professionals? Ask any banker or for that matter any financial professional what financial modeling is and they would reel off cost benefit analysis, cash flow projections, Net Present Value, expected rate of return, and break even points in a single breath. Further, for those of […]
Turnover ratios (also known as efficiency ratios) are a very important class of ratios. These ratios are not only used by financial personnel but also by the people in charge of operations. However, we are going to consider these ratios from the point of view of outside investors. This is because judgments have to be made about the efficiency of the firm based on limited information at hand. Here is an elementary introduction to what turnover ratios are and why they are important.
Over the years, investors have realized one rule and that is “Efficiency means growing business”. Any firm which is more efficient than its peers in producing the same goods and services will be more profitable in the short run. This profitability will allow the firm to build a competitive moat around itself and these businesses often become very valuable. This is like an investors dream formula for success. It is for this reason that investors carefully look at the efficiency numbers of newbie firms.
Finding out whether the firm is efficient is difficult even for a manager or an employee who has all the information at hand. Investors on the other hand just have the financial statements. They have to use these financial statements as their window into the operations of the firm. This is possible because every activity done by the firm involves costs and therefore leaves a trail on the financial statements. The turnover ratios are the investors’ method to connect the dots. They use information which is available in different financial statements. They then aggregate this information together and make meaningful conclusions about the operations of the company.
Turnover ratios as the name suggest, are related to sales. The logic is that given a certain amount of assets, how much sales can a company achieve? Therefore turnover ratios are always a comparison between an income statement item i.e. sales and the corresponding balance sheet item. For example if we compare fixed assets to sales, we get fixed asset turnover ratio. On the other hand when we compare accounts receivable to sales we get accounts receivable turnover ratio.
In case of inventory turnover ratio we use the COGS figure listed on the income statement rather than the sales figure. This is because inventory is reported at the cost price.
In conclusion, turnover ratios provide early clues to the efficiency of a firm. This can go a long way in making a successful investment and therefore an investor must learn how to use these ratios to his/her advantage.
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