Performance Ratios Look at Operational Issues
Emphasis is on Business Performance instead of Financial Performance
Apr 22, 2009
The business performance ratios examine a company's performance in:
- Utilizing the business assets optimally by balancing productivity and maintenance,
- Training and motivating employees to make them equipped and willing to play their roles competently and
- Managing inventories, receivables and production operations to speed up the throughput of funds
Good performance in these areas determines how successfully a company is building up shareholder value.
Major Performance Ratios
Fixed Assets Turnover Ratio = Revenue / Property, Plant and Equipment
Fixed assets of a business are the facilities needed to earn its revenues. The fixed asset turnover ratio computes how many times the outlay on these facilities have been covered by the revenues earned. The higher the turnover, the better the performance, indicating effective utilization of the assets, and also avoiding unnecessary investment in facilities.
Looked at another way, fixed assets turnover ratio measures how well the company's investment decisions turned out.
Sales Revenue per Employee = Revenue / Average Number of Employees during the Period
The per employee sales performance ratio measures revenue productivity, which is affected by employee selection, training, working environment and motivation. All decisions and activities of a company are carried out by individual employees and this ratio focuses attention on this aspect.
Both the above ratios are heavily dependent on the industry a company is in. Capital intensive industries need to invest heavily in fixed assets while service industries are typically labor intensive. Hence the ratios become meaningful only when used for comparing performance of similar businesses, or comparing performance of the same company over different periods.
Operating Cycle = Inventory in Days + Receivables in Days - Payables in Days
It should be noticed that operating cycle uses the same formula as the cash conversion cycle. The difference between the two is one of emphasis. While the cash conversion cycle focuses on the time it takes from inventory purchase to receipt of cash from customers, the operating cycle focuses on how well inventories, receivables and payables have been managed. Hence, it is a business performance ratio, rather than a financial performance ratio.
Significance of Operating Performance Ratios
The difference in emphasis between cash conversion cycle and operating cycle highlights the significance of performance ratios. We can say that financial performance ratios measure the final results, while the operating performance ratios force us to look at factors that contributed to these results. They help assess the performance of a company (compared to other companies in the same business, or its own past performance).
Operating performance ratios measure fixed assets turnover, employee performance in generating revenues and operating cycle of working capital turnover. They examine how well the company made its investment decisions, helped its employees to perform well, and managed its inventories, receivables and payables.
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