Question

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

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Answer

a. Asset turnover ratio measures the Sales/Revenue generating capacity of the total assets of the company.The amount of sales is compared to the total assets.The total sales are measured as a percentage of the total assets
ATR = Sales /Total assets * 100

b.INventory turnover ratio shows the number of times a company has sold its inventory and replaced the inventory over a period fo time.Higher is the ratio , higher is the efficiency in inventory management.
Inventory turnover ratio = Cost of good sold /Average Inventory
Average Inventory = (Beginning Inventory + Ending Inventory) / 2

c.Operating Cycle measures the duration that a business takes to manufacture /acquire the materials, process them , exchange them and receive the cash from the customers .
Operatng cycle =Day's sales in inventory(365/inventory turnover ratio ) + Average collection period (365/Accounts receivable turnover ratio)

D. Cash conversion cycle is a measure of the liquidity risk .It measures the time taken by a company to sell its inventory and collect its account receivables resulting from the credit sales from the customers. Shorter the cycle the better .IT is the operating cycle without the time taken in purchasing the materials or producing them .
CCC = time taken to sell the inventory + Time taken to collect cash from customers + Time taken to pay off its suppliers

E .Customer collection period is the time taken by a business to receive payments from its creditors. It is the time taken from the issuance of the invoice to the receipt of cash .It is used by the companies to know if they have enough cash to meet their short term financial obligations.
Collection perod = (Average amount receivables / Credit sales) * 365