Turnover Ratios Meaning and Example
Turnover Ratios Meaning
It measures how efficiently the assets are employed by a firm. These ratios are based on the relationship between the level of activity, represented by sales or cost of goods sold, and levels of various assets. The important turnover ratios are inventory turnover, Average collection period, receivables turnover, fixed assets turnover and total assets turnover.
Turnover Ratios Meaning
a. Inventory Turnover
The inventory turnover, or stock turnover, measures how fast the inventory is moving through the firm and generating sales. The formula is –
Cost of goods sold
Where Average Inventory = (Opening Stock + Closing Stock) /2
The Inventory turnover reflects the efficiency of inventory management. The higher the ratio, the more efficient the management of inventories and vice versa. However, a high inventory turnover is the result of low amount of inventory which may result in frequent stock outs and loss of sales and customer goodwill.
b. Debtor Turnover
This ratio shows how many times sundry debtors (accounts receivables) turn over during the year. It is defined as:
Net credit sales______
Average sundry debtors
If the figure for net credit sales is not available, one may have to make do with the net sales figure. Obviously, the higher the debtors’ turnover the greater the efficiency of credit management.
The average collection period represents the number of day’s a firm requires to recovers its money from the debtors. The formula is –
The average collection period refers to the efficiency of a firm in managing its credit. For example, if the credit terms are 2/10, net 45, an average collection period of 85 days means that the collection is slow and an average collection period of 40 days means that the collection is prompt.
d. Fixed Assets Turnover
This ratio measures sales per rupee of investment in fixed assets. The formula is:
Average net fixed assets
This ratio measures the efficiency of the fixed assets. A high ratio indicates a high degree of efficiency in asset utilization and a low ratio reflects inefficient use of assets.
e. Total Assets Turnover
The assets turnover is the ratio of net sales to average total assets.
Average total assets
This ratio measures how efficiently the firm is using its assets and generating income from it.