Open Banking – Meaning, Need, Advantages and Disadvantages
The field of commercial banking is undergoing many technological changes simultaneously. Open banking is one such technological change. Open banking is unique in the sense that this change has been initiated by regulators in most parts of the world. Generally, technological changes are adopted by commercial banks themselves with a view to increasing their productivity […]
Steps to Create a Financial Model
Financial modeling is not a perfect science. In fact, it would be fair to say that financial modeling is part art and part science. This is because the specific steps required to create a financial model cannot be chalked out. However, there is a broad framework which needs to be followed in order to create […]
Pension Funds and Income Redistribution
The purpose of pension funds is to ensure that the wealth created by an individual is invested and distributed in such a way that they can afford to maintain their standard of living throughout their lifetime. Pension funds have become a very important tool for retirement planning. An average pensioner plans to survive almost twenty […]
Compounding Intervals and Interest Rate
Theoretically there are two types of interest rates, simple and compounding. However, in finance the word interest usually refers to compound interest. Simple interest almost never factors in financial calculations. In all calculations related to present values and future values, compound interest is used. However, as a student of corporate finance, it is essential to […]
Financing Needs of Infrastructure Projects at Different Stages
Infrastructure projects typically last for many years. It is not uncommon for these projects to last for decades. These long term projects have different phases. Each of these phases has unique needs from a finance point of view, as well. In this article, we will explain how the financing needs of an infrastructure project depending […]
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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