Question

QUESTION 5 Explain what the following ratios measure.

a. Asset turnover:

b. Inventory turnover:

c. Operating cycle:

d. Cash conversion cycle:

e. Customer collection period:

Answer 1

Ans- a) Asset Turnover Ratio- It is the efficiency ratio that shows how effectively assets of the company are managed relative to its sales or revenue, it works as indicator of efficiency by which any company used its assets to revenue generation,

Formula= Net sales / Average total assets

Higher the result of this ratio signifies the higher efficiency of the company to used its assets and lower the result signifies the lower efficiency.

b) Inventory turnover ratio- It is also an efficiency ratio that shows how effectively inventory is managed by comparing cost of goods sold with average inventory for a period. This measures how many times average inventory is "turned" during a period

It also express relationship between cost of goods sold and inventory

Formula = Cost of goods sold/ Average stock

here, cost of goods sold= sales - Gross profit

Average stock= Opening stock+ Closing stock/ 2

c) Operating Cycle- It is the average period of time  during which a company receives cash from customers  well as pays to the  suppliers, every business needs to calculate is operating cycle so that production cycle do not stop and producttion may continue without any delay,

Operating Cycle= Raw material--------- Work in Progress--------- Finished Goods--------- Sales------Cash Received

This process goes on.

d) Cash Conversion Cycle-  Cash being the most important factor for every business and no one wants to block its cash for long period of time, the cash conversion cycle is used to calculate the time period (in days) in which the cash blocked by the company in terms of accounts receviables will available to pay to accounts payable,

short this cycle will help the business to expand the market.

e) Customer collection peroid- There is no business exist which purely works on cash basis, in every business credit period is allowed to its customers to pay , customer collection period is the avergae period taken by customers of the business to pay credit sales amount to business, it needs to be short to avoid any kind of bad debts   .