Lecture 11

Financial Planning
&
Financial Ratio Analysis
Part-2
3. TURNOVER RATIOS
• Turnover Ratios may be also termed as Efficiency Ratios or
Performance Ratios or Activity Ratios.
• Turnover Ratios highlight the different aspect of financial statement to
satisfy the requirements of different parties interested in the business.
• It also indicates the effectiveness with which different assets are
vitalized in a business.
• Turnover means the number of times assets are converted or turned
over into sales.
• The activity ratios indicate the rate at which different assets are turned
over.
3. TURNOVER RATIOS
• Following are activities or turnover ratios
1. Inventory Ratio or Stock Turnover Ratio
2. Debtor's Turnover Ratio or Accounts Receivable Turnover Ratio
3. A/R Collection Period Ratio
4. Creditor's Turnover Ratio or Payable Turnover Ratio
5. Debt Payment Period Ratio
6. Working Capital Turnover Ratio
7. Fixed Assets Turnover Ratio
8. Capital Turnover Ratio.
3. TURNOVER RATIOS
• (1) Stock Thrnover Ratio
• This ratio is also called as Inventory Ratio or Stock Velocity Ratio.
• This ratio is used to measure whether the investment in stock in trade
is effectively utilized or not.
• Stock Turnover Ratio indicates the number of times the stock has
been turned over in business during a particular period.
3. TURNOVER RATIOS
• (2) Debtor's Turnover Ratio or A/R Turnover Ratio
• Debtor's Turnover Ratio is also termed as Receivable Turnover Ratio
or Debtor's Velocity. Receivables and Debtors represent the
uncollected portion of credit sales.
• It indicates the number of times the receivables are turned over in
business during a particular period.
3. TURNOVER RATIOS
• 3. A/R or Debt Collection Period Ratio
• This ratio indicates the efficiency of the debt collection period and the
extent to which the debt have been converted into cash.
• This ratio is complementary to the Debtor Turnover Ratio. It is very
helpful to the management because it represents the average debt
collection period. The ratio can be calculated as follows:
3. TURNOVER RATIOS
Working Capital Turnover Ratio
• This ratio highlights the effective utilization of working capital with
regard to sales.
• This ratio represent the firm's liquidity position.
• It establishes relationship between cost of sales and networking
capital. This ratio is calculated as follows :
4. SOLVENCY RATIOS
• The term 'Solvency' refers to the capacity of the business to meet its
short-term and long term obligations.
• Short-term obligations include creditors, bank loans and bills payable
etc.
• Long-term obligations consists of debenture, long-term loans and
long-term creditors etc.
• Solvency Ratio indicates the sound financial position of a concern to
carryon its business smoothly and meet its all obligations.
4. SOLVENCY RATIOS
• Some of the important ratios which are given below in order to
determine the solvency of the concern :
• (1) Debt - Equity Ratio
• (2) Proprietary Ratio or Capital Ratio
• (3) Capital Gearing Ratio or Capitalization or Leverage Ratio
• (4) Debt Service Ratio or Interest Coverage Ratio
 4. SOLVENCY RATIOS
• (1) Debt Equity Ratio
• This ratio also termed as External - Internal Equity Ratio.
• This ratio is calculated to ascertain the firm's obligations to creditors in
relation to funds invested by the owners.
• The ideal Debt Equity Ratio is 1: 1.
• This ratio also indicates all external liabilities to owner recorded claims.
• It may be calculated as
5. OVERALL PROFITABILITY
RATIO
• This ratio used to measure the overall profitability of a firm on the
extent of operating efficiency it enjoys.
• This ratio establishes the relationship between profitability on sales
and the profitability on investment turnover.
• Overall all Profitability Ratio may be calculated in the following ways:
5. OVERALL PROFITABILITY
RATIO
• What Is the DuPont Analysis?
• The DuPont analysis (also known as the DuPont identity or DuPont
model) is a framework for analyzing fundamental performance
popularized by the DuPont Corporation.
• DuPont analysis is a useful technique used to decompose the different
drivers of return on equity (ROE).
• The decomposition of ROE allows investors to focus on the key
metrics of financial performance individually to identify strengths and
weaknesses.
• What DuPont Analysis Tells You?
• A DuPont analysis is used to evaluate the component parts of a
company's return on equity (ROE).
• This allows an investor to determine what financial activities are
contributing the most to the changes in ROE.
• An investor can use analysis like this to compare the operational efficiency
of two similar firms.
• Managers can use DuPont analysis to identify strengths or weaknesses
that should be addressed.
• There are three major financial metrics that drive return on equity (ROE):
1. operating efficiency
2. asset use efficiency
3. financial leverage.
• The Dupont analysis is an expanded return on equity formula,
calculated by multiplying the net profit margin by the asset turnover
by the equity multiplier.
 Example of DuPont Analysis Use
• An investor has been watching two similar companies, SuperCo and Gear Inc., that have
recently been improving their return on equity compared to the rest of their peer group.
This could be a good thing if the two companies are making better use of assets or
improving profit margins.
• In order to decide which company is a better opportunity, the investor decides to use
DuPont analysis to determine what each company is doing to improve its ROE and
whether that improvement is sustainable.
• Analysis of Super Co: As you can see in the table, SuperCo improved its profit
margins by increasing net income and reducing its total assets.
• SuperCo's changes improved its profit margin and asset turnover.
• The investor can deduce from the information that SuperCo also reduced
some of its debt since average equity remained the same.
• Analysis of Gear Inc: The investor can see that the entire change in ROE was
due to an increase in financial leverage.
• This means Gear Inc. borrowed more money, which reduced average equity.
• The investor is concerned because the additional borrowings didn't change
the company's net income, revenue, or profit margin, which means the
leverage may not be adding any real value to the firm.