Turnover Ratios

Turnover ratios measure the degree to which assets are efficiently employed in a firm. They are also referred to as activity or asset management ratios. The major turnover ratios are:

• Inventory turnover ratio

  The inventory turnover ratio measures the speed with which inventory is converted into sales for the firm. It reflects the efficiency of the firm’s inventory management and is calculated as –

                               Cost of goods sold
                               Average inventory

Here, average inventory is considered, since the level of inventories changes over the course of the year.

A high inventory turnover ratio indicates greater efficiency of inventory management of the firm. However, a high inventory turnover may also be caused due to low levels of inventory, leading to frequent depletion of stock and loss of sales for the firm.

• Accounts receivables turnover ratio

This ratio computes the number of times accounts receivables are turned over during the year. It is calculated as –

                                    Net credit sales
                          Average Accounts Receivables

The higher the accounts receivables turnover, the greater is the managerial efficiency.

• Average collection period

  The average collection period represents the number of days for which credit sales are locked in with debtors (as accounts receivables). It is calculated as –

                              Average Accounts Receivables
                                Average Daily Credit Sales

The average collection period is compared with the firm’s credit terms to evaluate the efficiency of its credit management. Suppose the firm’s credit terms are 2/10, net 45. An average collection period of 85 days implies that collection is slow, while an average collection period of 40 days implies that it is timely. However, an average collection period that is less than the credit period set by the firm may also mean that the firm does not grant credit easily, which results in loss of sales.  

• Fixed assets turnover ratio

  The fixed assets turnover ratio measures the sales per rupee of investment in fixed assets and is calculated as –

                                   Net Sales
                         Average Net Fixed Assets

This indicates the efficiency of the firm in utilising its fixed assets. A higher ratio indicates greater efficiency while a lower ratio indicates lesser efficiency. However, if the firm’s assets are old and have depreciated substantially in value, the denominator would be low, giving a high fixed assets turnover ratio.  

• Total assets turnover ratio

  The total assets turnover ratio measures the sales per rupee of investment in the total assets of the firm, i.e. the efficiency with which all the assets are being utilised. It is calculated as –

                              Net Sales 
                       Average Total Assets