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Ratio Analysis. Short-term liquidity. Part 2.

Accounts receivable turnover ratio (AccRTurn) equals Net Credit Sales divided by Average Accounts Receivable (AvAccR). If credit sales data is not available, we will use Net Sales.

Note that the Balance Sheet component (Accounts Receivable) and the Income Statement component (Net Credit Sales) meet in the same ratio, hence the Balance Sheet amount should be an average for the period (if the average of the beginning and ending receivables is not representative because of cyclical factors, a monthly or quarterly average is preferable).

AvAccR = (AccR1 + AccR2)/2,
where AccR1 - beginning Accounts Receivable, AccR2 - ending Accounts Receivable.

receivables_turnover.gif


Days sales in receivables, also called the average collection period, is the average number of days to collect a receivable. Days sales in receivables (DaysR) equals Average Accounts Receivable divided by Average daily sales (AvDailySales). The identical definition: Days sales in receivables equals the number of days in the period (365, 360 or 300) divided by the Account receivable turnover.

days_sales_in_receivables.gif

The Inventory turnover ratio (InvTurn) equals Cost of Sales divided by Average Inventory (AvInv). Note that numerator is Cost of Sales, not Net Credit Sales. The calculation of average inventory is analogous to calculation of average receivables.

AvInv = (Inv1 + Inv2)/2,
where Inv1 - beginning Inventory, Inv2 - ending Inventory. You should use monthly or quarterly average inventory if it is necessary.

inventory_turnover.gif


Days sales in inventory (DaysInv) is the average number of days that inventory is held before sale. Days sales in inventory equals the number days in the year (365, 360 or 300) divided by the Inventory turnover ratio. Days sales in inventory may also be computed as Average Inventory divided by the Average daily cost (AvDailyCost)

Days_sales_in_inventory-.gif


Operating cycle, which is also known as the cash-to-cash cycle, is the length of time for a company to acquire materials, produce the product, sell the product, and collect the proceeds from customers. Therefore, operating cycle may be estimated by adding Days sales in inventory to Days sales in receivables.

Operating cycle = Days sales in inventory + Days sales in receivables

In the final chapter we will consider the definition and calculation of the Liquidity Index.

List of notations

Posted by mazoo at June 24, 2005 4:25 PM

Related posts:

Ratio Analysis. Liquidity Index. Part 3. Jul 01, 2005
Ratio Analysis. Short-term liquidity. Part 1. May 27, 2005
Ratio Analysis. Return on Invested Capital May 03, 2005

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Posted by: Mohammed jindias at January 10, 2008 7:35 PM