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How efficiently is your company running?
Accounts Receivable Turnover
One thing that can kill an otherwise profitable company is poor cash flow, and all too often, that happens from slow receivables turnover. Conversely, as a strategic consultant, one of the first things, you can often do, to improve a company’s financial health, is work on strategies for improving collections.
Accounts Receivable turnover is calculated by taking net credit sales divided by average net receivable for the period.
Remember that return on Assets ratio we looked at? On of those assets that is included in total assets, is inventory. If the company is locking up too much cash in inventory, then your ROA will be decreased, and you also run the risk of obsolescence. In other words, we want to be sure that we’re being as efficient as possible with our inventory.
Inventory turnover can be calculated a number of ways (google it). For this exercise we’ll take Cost of Goods Sold and divide it by average inventory for the period.
Asset turnover looks at the amount of sales generated for every dollar of assets. How efficiently are our assets generating sales for us?
Asset Turnover is calculated by dividing sales in dollars by assets in dollars.
It also indicates pricing strategy: companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover. It’s important to understand that this is because companies with low profit margins, generate more sales. That’s the reason why you operate with a low profit margin – you’re expecting to generate your profits by keeping your fixed costs low, so that your increased volume translates to the bottom line.