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Operating ratios

By linking various income statement and balance sheet figures, these measures provide an assessment of a company's operating efficiency.
  • Asset turnover: This shows how efficiently a company uses its assets. To calculate asset turnover, divide sales by assets. The higher the number, the better.
  • Days receivables: It's best to collect on receivables promptly. This measure tells you in concrete terms how long it actually takes a company to collect what it's owed. A company that takes 45 days to collect its receivables will need significantly more working capital than one that takes four days to collect. To calculate days receivables, divide net accounts receivable for the given time period by net sales, then multiply that quotient by 365.
  • Days payables: This measure tells you how many days it takes a company to pay its suppliers. The fewer the days it takes, the less likely the company is to default on its obligations. To calculate days payables, divide accounts payable by the cost of goods sold for the period in question, and then multiply that quotient by 365.
  • Days inventory: This is a measure of how long it takes a company to sell the average amount of inventory on hand during a given period of time. The longer it takes to sell the inventory, the greater the likelihood that it will not be sold at full value—and the greater the sum of cash that gets tied up. To calculate days inventory, divide the average amount of inventory on hand for the period by the cost of goods sold for the same period, then multiply that quotient by 365.
  • Current ratio: This is a prime measure of how solvent a company is. It's so popular with lenders that it's sometimes called the banker's ratio. Generally speaking, the higher the ratio, the better financial condition a company is in. A company that has $3.2 million in current assets and $1.2 million in current liabilities would have a current ratio of 2.7 to 1. That company would be generally healthier than one with a current ratio of 2.2 to 1. To calculate the current ratio, divide total current assets by total current liabilities.
  • Quick ratio: This ratio isn't faster to compute than any other—it simply measures the ratio of a company's assets that can be quickly liquidated and used to pay debts. Thus, it ignores inventory, which can be hard to liquidate (and if you do have to liquidate inventory quickly, you typically get less for it than you would otherwise). This ratio is sometimes called the acid test ratio because it measures a company's ability to deal instantly with its liabilities. To calculate the quick ratio, divide cash, receivables, and marketable securities by current liabilities.
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