block2 6operativeratios

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OPERATIONAL RATIOS

E-LEARNING COURSE: ACCOUNTING & FINANCES

OPERATIONAL RATIOS

How can we know if the amount of money invested is adequate for the business?

We will leave aside investments in fixed assets, which exceed the scope of this block.

Let’s focus on investments in current assets. Looking only at the figure of dollars invested in customer receivables, or in inventories, it is not easy to make any judgement about the necessity of its necessity or efficiency .

So it is useful to transform figures in dollars into operational ratios, normally days, since this can help us form an opinion on the efficiency of management. Let’s examine the following items on the BS:

• Cash: days of expenses• Account receivables: collection period• Stocks: days of inventory• Account payables: payment period

Cash

Account Receivables

Inventory(or Stock)

Account Payables

• It is not easy to estimate how much cash a firm needs to operate efficiently without any trouble, but financial specialists often find it useful to think of “days of expenses” that can be paid with actual cash without collecting any additional money.

• Commercial firms frequently compute this ratio using only CGS.

Cash

Cash

Account Receivables

Inventory(or Stock)

Account Payables

Cash

Cash

Account Receivables

Inventory(or Stock)

Account Payables

• It is not easy to estimate how much cash a firm needs to operate efficiently without any trouble, but financial specialists often find it useful to think of “days of expenses” that can be paid with actual cash without collecting any additional money.

• Commercial firms frequently compute this ratio using only CGS.

Note:We are assuming that year end statements are being used, so any figure in the P&L refers to a complete year. If we use quarterly statements, we must divide by 90, and by 30 if monthly statements are used.If the firm is seasonal, attention must be paid to the date when the statements are formulated. It is recommended to use quarterly or monthly P&L data to compute all the operational ratios in seasonal firms.

Example - CASH

Here are the financial statements of a commercial firm for the year 2013

P & L Year 2013Sales 1,854

-Cost of goods sold 1,315

Gross margin 539

- Operating Expenses 215

EBITDA 324

B.S. items 31/12/2012 31/12/2013

Cash 65 85

Receivables 320 420

Inventory 183 210

Payables 260 256

𝐷𝑎𝑖𝑙𝑦 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠=𝑐𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠𝑠𝑜𝑙𝑑+𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑎𝑙 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠365

= 4.2

𝐷𝑎𝑦𝑠𝑜𝑓 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠= 𝐴𝑐𝑡𝑢𝑎𝑙 h𝑐𝑎𝑠𝐷𝑎𝑖 𝑙𝑦 𝑒𝑥𝑝𝑒𝑛𝑠𝑒

= 20 days

Example




Gross margin 539


EBITDA 324

B.S. items 31/12/2012 31/12/2013

Cash 65 85

Receivables 320 420

Inventory 183 210

Payables 260 256

We have cash enough to pay for 20 days of expenses.

Collection period

• What I have in receivables has been sold during the last ‘x’ days. In the real world, some of the sales made in that period may be collected and some may not, so we use average ratios. We want to know the equivalent collection period using average daily sales.

In countries where sales are taxed with V.A.T., accounts receivable in the B.S. include VAT, but sales in the P&L do not. So we must use different formulae:

Cash

Account Receivables

Inventory(or Stock)

Account Payables

Example- Receivables




Gross margin 539


EBITDA 324

B.S. items 31/12/2012 31/12/2013

Cash 65 85

Receivables 320 420

Inventory 183 210

Payables 260 256

𝐷𝑎𝑖𝑙𝑦 𝑠𝑎𝑙𝑒 𝑠=𝑠𝑎𝑙𝑒𝑠365

= 5.1

𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛𝑝𝑒𝑟𝑖𝑜𝑑=𝑅𝑒𝑐𝑖𝑣𝑎𝑏𝑙𝑒𝑠𝐷𝑎𝑖𝑙𝑦 𝑠𝑎𝑙𝑒𝑠

= 83 days

Example - RECEIVABLES




Gross margin 539


EBITDA 324

B.S. items 31/12/2012 31/12/2013

Cash 65 85

Receivables 320 420

Inventory 183 210

Payables 260 256

We have enough cash to pay for 20 days of expenses.

Our collection period is 83 days of sales.

Inventory

• What I have in the inventory will be sold during the next “x” days. Everything that we are going to sell in the next “x” days is already in the warehouse. For inventory calculations we must use the cost of goods sold instead of sales.

• When growth is important, it is better to use future c.g.s. forecasts instead of past c.g.s.

Cash

Account Receivables

Inventory(or Stock)

Account Payables

Example - Inventory




Gross margin 539


EBITDA 324

B.S. items 31/12/2012 31/12/2013

Cash 65 85

Receivables 320 420

Inventory 183 210

Payables 260 256

𝐷𝑎𝑖𝑙𝑦 𝑐 .𝑔 .𝑠=𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠𝑠𝑜𝑙𝑑365

= 3.6𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛𝑝𝑒𝑟𝑖𝑜𝑑=

𝑆𝑡𝑜𝑐𝑘𝐷𝑎𝑖 𝑙𝑦 𝑐 .𝑔 .𝑠

= 58 days

Example - RECEIVABLES




Gross margin 539


EBITDA 324

B.S. items 31/12/2012 31/12/2013

Cash 65 85

Receivables 320 420

Inventory 183 210

Payables 260 256



We have stock in our warehouses for 58 days of sales.

Payment period

• What I have in payables has ben purchased during the last “x” days. As we did with customer receivables, we will use average daily purchases.

• To calculate purchases, we must add inventory increases (or subtract stock decreases) to the cost of goods sold.

• In countries with V.A.T.

Cash

Account Receivables

Inventory(or Stock)

Account Payables

Example - PAYABLES




Gross margin 539


EBITDA 324

B.S. items 31/12/2012 31/12/2013

Cash 65 85

Receivables 320 420

Inventory 183 210

Payables 260 256

𝐷𝑎𝑖𝑙𝑦 h𝑝𝑢𝑟𝑐 𝑎𝑠𝑒𝑠=𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠𝑠𝑜𝑙𝑑+(𝐹𝑖𝑛𝑎𝑙 𝑠𝑡𝑜𝑐𝑘− 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑠𝑡𝑜𝑐𝑘)365

= 3.7

𝑃𝑎𝑦𝑚𝑒𝑛𝑡𝑝𝑒𝑟𝑖𝑜𝑑=𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠

𝐷𝑎𝑖𝑙𝑦 h𝑝𝑢𝑟𝑐 𝑎𝑠𝑒𝑠

= 71 days

Example - PAYABLES




Gross margin 539


EBITDA 324

B.S. items 31/12/2012 31/12/2013

Cash 65 85

Receivables 320 420

Inventory 183 210

Payables 260 256



We have stock in our warehouses for 58 days of sales.

Our payment period is 71 days of purchases.

block2 6operativeratios

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