UNDERSTANDING OPERATIONAL RATIO OF FUNDAMENTAL ANALYSIS
Fundamental analysis is very important as it helps you to understand about the company which you are interested to make an investment. Financial ratio’s helps to understand the company in the most simplified manner and was made popularized by the father of fundamental analysis ‘Benjamin Graham’. Let’s understand operational ratios of fundamental analysis . Financial ratio’s includes operational ratios , leverage ratios , valuation ratios and profitability ratios. Operational ratio indicates the efficiency in which assets of the company are utilized. Operating ratio are also called activity ratio or management ratio. fundamental analysis is a vital tool for successful investing. It provides investors with a thorough understanding of a company’s financial health, management team, industry dynamics, and long-term prospects, enabling them to make informed investment decisions based on solid data and analysis. By employing fundamental analysis in their investment process, investors can mitigate risks, identify opportunities, and increase their chances of achieving their financial goals. Having a bright idea about fundamental analysis and its ratios helps an investor to understand the financial health of a company in depth just by analyzing the ratios.
Lets understand the operational ratios in depth to understand how the operational performance of a company is performing. Major operational ratios are as follows
1. FIXED ASSET TURNOVER RATIO
Fixed asset turnover ratio measures the extent of revenue generated in comparison of its investment in fixed assets. it tells us how effectively a company utilizes its plant and machinery. Higher the ratio means company is effectively managing its fixed assets.
FIXED ASSET TURNOVER RATIO = OPERATING REVENUE / AVG OF FIXED ASSETS
2. TOTAL ASSET TURNOVER RATIO
Total asset turnover ratio indicates a company’s capability to generate revenue with given amount of assets. Here assets indicates both fixed and current assets. Higher the ratio means company is effectively managing its assets to generate more revenue .
TOTAL ASSET TURNOVER RATIO = OPERATING REVENUE / AVG TOTAL ASSETS
3. WORKING CAPITAL TURNOVER RATIO
If working capital turnover ratio is positive , it means that having has a working capital surplus and can easily manage day to day operation. If working capital is negative , it means company has a working capital deficit, they seek loan from bankers for day to day operations.
WORKING CAPITAL TURNOVER CAN BE FOUND BY TOTAL REVENUE / AVERAGE WORKING CAPITAL
If a company has a working capital of 2 rs it indicates company is able to generate 2 rs by using working capital of rs 1.
4. INVENTORY TURN OVER RATIO
The inventory gets cleared rapidly if a company is selling popular and high quality products , then the company has to replenish the inventory time again and again. If product has higher sales the inventory turnover would be high.
INVENTORY TURNOVER CAN BE FOUND BY COST OF GOODS SOLD / AVG INVENTORY
COST OF GOODS SOLD = COST OF MATERIALS CONSUMED + PURCHASE OF STOCK IN TRADE + STORES AND SPARES CONSUMED + POWER AND FUEL + COST OF PACKING MATERIALS.
If inventory turnover is 5 , that means that inventory is turned over 5 times in an year
5. INVENTORY NUMBER OF DAYS
Inventory number of days gives an idea about in how much days the company takes to convert its inventory into cash. Lesser the inventory number of days the better the company’s inventory is becoming converted in cash and it is one of the best ratio to understand operational performance of a company.
INVENTORY NUMBER OF DAYS CAN BE FOUNDED BY 365 DIVIDED BY THE INVENTORY TURNOVER
6. ACCOUNTS RECIEVABLE TURNOVER RATIO
This ratio helps to understand how many times in a given period , the company receives cash from its debtors and customers. Higher number indicates the company collects cash more frequently from its debtors and customers.
ACCOUNTS TURNOVER RATIO = OPERATING REVENUE / AVG RECIEVABLES
7. DAY SALES OUTSTANDING (DSO) RATIO
DSO ratio indicates the average cash collection period , it indicates the time lag between billing and collection. This ratio shows the efficiency of company’s collection department.
DSO = 365 / RECIEVABLE TURNOVER RATIO