Operating performance ratios
/Operating performance ratios are intended to measure different aspects of an organization's core operations. The focus of these measurements is on the efficient use of resources to generate sales, as well as how well assets can be converted into cash. A business with excellent performance ratios can generate a high level of sales with relatively few resources, and generates a high level of cash inflows. The essential operating performance measurements are noted below.
Fixed Asset Turnover
Fixed asset turnover compares revenues to net fixed assets. A high ratio indicates that a business is generating a large amount of sales from a relatively small fixed asset base. The formula is net sales divided by net fixed assets. The ratio can yield false results if a business is using very old assets to generate sales; at some point, those assets must be replaced. The measurement is less useful in a services business, which tends to operate with few fixed assets. The formula is:
Net annual sales ÷ (Gross fixed assets - Accumulated depreciation) = Fixed asset turnover
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Operating Cycle
The operating cycle is the average period of time required for a business to make an initial outlay of cash to produce goods, sell the goods, and receive cash from customers in exchange for the goods. A company with an extremely short operating cycle requires less cash to maintain its operations and so can still grow while selling at relatively small margins. Conversely, a business may have fat margins and yet still require additional financing to grow at even a modest pace, if its operating cycle is unusually long. Subsets of the operating cycle can be examined by reviewing accounts receivable turnover, inventory turnover, and accounts payable turnover.
To keep the operating cycle short, managers tend to focus on collecting receivables as soon as possible, maintaining low inventory levels, and paying suppliers as late as possible.
Sales per Employee
Sales per employee compares revenues to the number of employees. A high ratio indicates that a business is creating a large volume of sales with very few employees. The formula is net sales divided by the number of full time equivalents. The ratio can yield false results if a business is outsourcing a large amount of work or using a large number of contractors. The measurement tends to be relatively low for services businesses, where sales are generated from billable employee hours. The formula is:
Annualized net sales ÷ Total full-time equivalents = Sales per employee