Receivable Days

Receivable days measures the average no of days that a company takes to collect revenue, after a sale has been made. This ratio is an index of the relationship between outstanding receivables and sales achieved over a given period of time.

When a company does credit sales, company will have debtors. There is a credit policy which specifies the no of days given for the customers to pay their amount dues. Thereby the no of days extended depend on the industry. Management should be efficient to collect its debts quickly. Actually this ratio measures the management efficiency. Because it’s important for the liquidity of the company. When the company turns the sales into cash quickly, the company gets a chance to place the cash to use again, normally to reinvest and make more sales.

When the company shortens the receivable days too much it could lose customers. Same as that if the company gives more time for the customers to pay their bills then the company might face a cash shortage. Less no of days is better for the company.

Sometimes high no of receivable days indicates the customers are dissatisfied with the company's product or service, or sales are being made to customers that are less credit-worthy, or sales people have to offer longer payment terms in order to generate sales. 

Receivable Days              =              Closing trade receivables x 365

                   Revenue

Inventory Days

Successful inventory management is an essential part of a company. Too much inventory means paying for storage, possible waste or theft, the opportunity cost that the time and space used to hold onto inventory that remains unsold could have been used instead to buy products that would sell. Having too little inventory, on the other hand, could lead to shortages and possibly missed sales opportunities.

Inventory days indicate the average no of days goods remain in the inventory before being sold. The process of turning of raw materials into cash. Inventory days can be called as days cover, days of inventory or days sales to inventory.

 Inventory days        =               Closing Inventory x 365

                                                       Cost of sales (Revenue)

Lower the no of days in the inventory emphasis the company efficiency. It increases the company liquidity level as well. In other hand low inventory days indicates company is not keeping enough stock on hand to meet demands. Higher the no indicates that there is lack of demand for the product being sold.

Payable Days

Accounts Payables are the debts that must be paid off with in a given period of time. It is the unpaid invoices, bills statement of goods or services rendered by the outside contractors, vendors or suppliers. There is a credit policy which agreed between the company and other party like suppliers. Accounts payables are often referred to as “Payables”. This is a ratio measures how long a company is taking to pay its trade creditors. Trade payables appears on the company‘s balance sheet under current liability section.

Paying bills on time and according to the specific terms and conditions can affect company credit ratings and ultimately business relationships. If the payable days are low it implies that the company pays its liabilities quickly. Normally it’s better to have a larger no of payable days. Because the longer company holds money before paying its bills, company could earn more money by placing money in the bank. This is only true if the company does pay its creditors. But if the company takes long time to settle the payments, the company will be considering as a not worthy company in the industry.

But there may be different terms and conditions exist in which payment for a service is expected. Such as some of the services require payment upon receipt, which means compensation is due immediately after the service is rendered. Others have 10, 30, or 90 day terms in which payment is accepted. Not only that in credit lines, where payment is due once a month, is also a standard practice.

However the accounts payable administrator should keep track of terms and conditions, whether they are following accordingly, otherwise it will create a bad impression of the company within the industry.

                    Payable Days              =           Closing trade payables x 365

         Cost of sales

Asset Turnover

Asset Turnover measures the company’s efficiency, productivity at using its assets in generating sales or revenue. Sometimes this ratio is referred as efficiency ratio, asset utilization ratio or asset management ratio.

Every company had assets of some sort, even it’s a home based business or an international conglomerate, and every company produces goods and services for sale to a consumer market. The asset turnover can be very helpful in measuring progress in each and every area.

Asset Turnover indicates the relationship between the net assets employed and the revenue it yields. This ratio is useful to determine the amount of sales that are generated from each penny of assets. Therefore this ratio is much useful for the growth of the companies to check whether their growing revenue is proportion to sales.  A company should have a proper balance maintained between debt and equity. It indicates a pricing strategy as companies with low profit margins tend to have high asset turnover and those with high profit margins have low asset turnover.

High ration is considered desirable for the company, it indicates the company operating performance. A higher asset turnover ratio represents greater shareholder wealth. A low asset ration means inefficient utilization of fixed assets. Revenue value can be taken from the company’s income statement and the net assets from the balance sheet.

Asset Turnover   =    Revenue

                               Net assets

Debt to Total Assets Ratio

Debt to Total Assets ratio measures a company's financial risk which determines how much of company’s assets have been financed by debt. This ratio measures company’s solvency as well. This is a very broad ratio which includes all the short-and long-term debt and all types of both tangible and intangible assets.

If the ratio is less than one indicates the company’s assets are financed through equity. Same as that ratio is greater than one, most of the company’s assets are financed through debt. Higher the ratio the greater the risk will be associated. More than that higher the ratio indicates the low borrowing capacity of a firm, which in turn will indicate financial flexibility. The number it yields tells investors a number of things.

To improve the Debt to Assets ratio, a company could do so many things like debt-equity swap, an additional stock issue or selling assets to pay down some of the debt. Therefore companies use strategies depending on the conditions and how much they want to improve that debt/asset ratio number.

Actually this ratio differ from one company to another, depend on the company specific situations. Some companies manage to do well with the high no ratio due to number of reasons.

Total Debt x 100

 Total Assets

Advantages and Disadvantages of High Gearing

Advantages of High Gearing

Borrowing may allow the firm to take on profitable projects

Taking on more profitable projects may allow the company to expand and in the future reduce its Gearing ratio

Borrowing may be a quick and cheap form of financing a project compared to other means such as share issues which may not all be taken up

Disadvantages of High Gearing

If the company has low profits then it may struggle to meet interest payments, leading to a higher risk of being liquidated

The firm may find it harder to get further loans, since investors will be put off by the high gearing level

Advantages and Disadvantages of Low Gearing

Advantages of Low Gearing

Changes in interest rates especially upward trends have a lower effect on the firm

Less risk of liquidation occurring due to not being able to pay off interest payments

Reduced Interest payments, so more investment can occur elsewhere and the firm can have more cash flow to take on bigger and potentially more profitable projects

Disadvantages of Low Gearing

The firm is expected to make regular dividend payments

The higher ratio of Shareholder funds will mean that the company will now be owned by its shareholders more relatively.

Gearing Ratio

Gearing Ratio I

Gearing Ratio            =                         Debt x 100

                                                             Equity

Variations to the basic quantification,

Gearing Ratio II

Gearing Ratio         =        Debt       x 100

                                        Debt + Equity

Expresses debt as a function of total   funding profile

What is Gearing?

Gearing is a tool that is used by investors and businesses to show how much of the long term finance came from loans and how much came from shareholder funds. It also shows how exposed the firm is to financial risk.

Gearing Ratio

The Gearing Ratio looks at the level of borrowing that a company has taken on in the form of loans and compares that to the total long term finance that a business has.

As a ratio, obtain a percentage figure from the formula. Since the formula shows the ratio of Loans to (shareholder funds + Loans), the percentage obtained tells us a few things.

High Gearing – where a high % of the long term finance is in the form of loans. A high percentage is a figure that is over 50%.

Low Gearing – where a low % of the long term finance is in the form of loans. A low percentage is a figure that is between 0% and 50%

What Does the Gearing Figure mean for the Business and Shareholders?

Gearing shows a firms exposure to financial risk. A high gearing percentage tells us that the firm has a high level of loans compared to shareholder funds. The high level of loans also means that the firm has to pay a higher interest charge. This means that if profits were low, or did not meet predicted levels then the firm would have a tough time paying off the interest charges, which would affect other areas of the firm e.g. a lower investment into Research & Development for a year. So the greater the gearing percentage the greater the exposure to risk and the risk of interest rate rises.

For shareholders and potential investors the gearing level is important, and as such it is a very important tool when analyzing whether a business is a viable investment:

Potential investors view firms that are highly geared as being a risky investment

Higher gearing raises the exposure to interest rate changes, so investors will be put off investing if they feel that interest rates will rise

Higher gearing means that the company will be in risk of liquidation if it cannot meet interest payments

Investors looking to give a loan to the company will also look at the gearing ratio

A highly geared company will already be paying high interest charges, so investors will be put off from give it a further loan as the firm may not be able to pay it back

A low geared firm is more likely to get a loan from investors since its loan payments are low, and its exposure to risk is also low.