What do utilization ratios say about a firm’s performance?

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One of the key characteristics of a financially sound firm lies in its efficiency in utilizing its capital. Utility ratios such as asset turnover, fixed asset turnover, working capital turnover, and ratios such as invested capital turnover and equity turnover (which show the capital utilization by the company) help the investors in gaining clear insights on the performance of the companies in which they have invested.

Hypothetical illustration

 Let us clear the concepts with an example: Take a company Abhan Harsh Ltd (AH) and its latest financial year figures: Property plant and equipment (PPE) 10,000; current liabilities 3,000; sales revenue 20,000; shareholders’ funds 12,000, total assets 24,000; current assets 8,000; (all figures are in Rs crores)

Asset Turnover

 Asset turnover is calculated by dividing the Revenue of the firm by its total assets. For AH, it is 0.83 times (Rs 20,000 crore / Rs 24,000 crore). This shows AH generates a revenue of Rs 83 for every Rs 100 invested in its assets.

Working Capital Turnover

 It is calculated by dividing the revenue of a firm by its working capital. For AH, it is four times (Rs 20,000 crore / Rs 5,000 crore). Working capital is computed as current assets minus current liabilities. This reveals AH is makes a revenue of Rs 4 for every Rs 1 that is invested in its working capital. 

Fixed Asset Turnover

 We calculate this ratio by dividing the revenue of the firm by its fixed assets. For AH, this ratio is 2 times (Rs 20,000 crore/ Rs 10,000 crore). This tells us that AH generates revenue of Rs 2 for every Rs 1 that is invested in its tangible fixed assets.

The above three ratios take into consideration the investment utilization by comparing the sales revenue by the different types of assets. But investors also want to know how the company utilizes its capital. 

Invested Capital Turnover

 It is computed by dividing the revenue of a firm by its invested capital. For AH, it is 0.95 times (Rs 20,000 crore / Rs 21,000 crore). which indicates that AH is generating revenue of Rs 95 for every Rs 100 of the capital invested.

Equity Turnover

 We get this number by dividing the revenue of a firm by its shareholder’s funds. For AH, it is 1.67 times (Rs 20,000 crore / Rs 12,000 crore). This shows that AH is generating sales revenue of Rs 167 for every Rs 100 of its shareholders’ funds. 

The higher the output, the better is the utilization of capital employed and capital invested in the case of all the five ratios. One could do a comparative firms’ analysis to get more insights.

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