Interpretation of Inventory Turnover Ratio Inventory turnover ratio is an efficiency ratio that measures how well a company can manage its inventory. It is important to achieve a high ratio, as higher turnover rates reduce storage and other holding costs. It is vital to compare the ratios between companies operating in the same industry and not for companies operating in different industries. The benchmark ratio varies greatly depending on the industry. Low turnover implies that a company’s sales are poor, it is carrying too much inventory, or experiencing poor inventory management. Unsold inventory can face significant risks from fluctuating market prices and obsolescence. Depending on the industry that the company operates in, inventory can help determine its liquidity. For example, inventory is one of the biggest assets that retailers report. If a retail company reports a low inventory turnover ratio, the inventory may be obsolete for the company, resulting in lost sales and additional holding costs. Key Takeaways Inventory turnover ratio is an efficiency ratio that measures how efficiently inventory is managed. The ratio should only be compared for companies operating in the same industry, as the ratio varies greatly depending on the industry. A high ratio is always favorable, as it indicates reduced storage and other holding costs. A low ratio implies poor sales, excess inventory, or inefficient inventory management. Depending on the industry, the ratio can be used to determine a company’s liquidity. Interpretation of Accounts Receivable Turnover Ratio The accounts receivable turnover ratio is an efficiency ratio and is an indicator of a company’s financial and operational performance. A high ratio is desirable, as it indicates that the company’s collection of accounts receivable is frequent and efficient. A high accounts receivable turnover also indicates that the company enjoys a high-quality customer base that is able to pay their debts quickly. Also, a high ratio can suggest that the company follows a conservative credit policy such as net-20-days or even a net-10-days policy. On the other hand, a low accounts receivable turnover ratio suggests that the company’s collection process is poor. This can be due to the company extending credit terms to non-creditworthy customers who are experiencing financial difficulties. Additionally, a low ratio can indicate that the company is extending its credit policy for too long. It can sometimes be seen in earnings management, where managers offer a very long credit policy to generate additional sales. Due to the time value of money principle, the longer a company takes to collect on its credit sales, the more money a company effectively loses, or the less valuable are the company’s sales. Therefore, a low or declining accounts receivable turnover ratio is considered detrimental to a company. It’s useful to compare a company’s ratio to that of its competitors or similar companies within its industry. Looking at a company’s ratio, relative to that of similar firms, will provide a more meaningful analysis of the company’s performance rather than viewing the number in isolation. For example, a company with a ratio of four, not inherently a “high” number, will appear to be performing considerably better if the average ratio for its industry is two. What is the Accounts Payable Turnover Ratio? Accounts payable turnover is a ratio that measures the speed with which a company pays its suppliers. If the turnover ratio declines from one period to the next, this indicates that the company is paying its suppliers more slowly, and may be an indicator of worsening financial condition. A change in the turnover ratio can also indicate altered payment terms with suppliers, though this rarely has more than a slight impact on the ratio. If a company is paying its suppliers very quickly, it may mean that the suppliers are demanding fast payment terms, or that the company is taking advantage of early payment discounts. ROSF - Return on total equity (ROE) is used to measure the overall profitability of the company from preference and common stockholders’ point of view. The ratio also indicates the efficiency of the management in using the resources of the business. Higher ratio means higher return on shareholders’ investment and a lower ratio indicates otherwise. Investors always search for the highest return on their investment and a company that has higher ROE ratio than others in the industry attracts more investors. Investors can also use ROCE figure to analyze the performance of a company or compare the performances of different companies within the same sector. If 2 companies in same sectors have more or less same amount of capital employed, the company with better ROCE would, without the doubt, have made a better use of the employed funds. We can safely assume that such a company would have made better use of its resources. Increased debt brings with it higher fixed costs that must be paid in good times and bad, and can severely limit a company's flexibility," reports the Encyclopedia of Business (2nd Ed.). Though lowcost debt can make for a good investment, companies with no long-term debt do not have to worry about paying off long-term debt when times are tough. During recessions or down times for a particular business, a tremendous advantage for companies is not having to make large principal and interest payments on debt.
