Tag: Modern Marketing Bangalore University BBA Notes

A short-term loan is a type of loan that is obtained to support a temporary personal or business capital need. As it is a type of credit, it involves repaying the principal amount with interest by a given due date, which is usually within a year from getting the loan.

Short-term debt, also called current liabilities, is a firm’s financial obligations that are expected to be paid off within a year. It is listed under the current liabilities portion of the total liabilities section of a company’s balance sheet.

Objectives

• To be able to take the necessary steps to establish credit and develop a credit history.
• To evaluate reasons for and against using credit and decide whether credit is appropriate.
• To identify what is meant by sales credit and how it is used.
• To identify the important characteristics of installment loans.
• To understand how to use credit cards properly and to know your legal rights as a borrower against credit mistakes.
• To compare the various sources of credit and to learn what to do if you experience credit problems.

Types:

Invoice financing

This type of loan is done by using a business’ accounts receivables invoices that are, as yet, unpaid by customers. The lender loans the money and charges interest based on the number of weeks that invoices remain outstanding. When an invoice gets paid, the lender will interrupt the payment of the invoice and take the interest charged on the loan before returning to the borrower what is due to the business.

Payday loans

Payday loans are emergency short term loans that are relatively easy to obtain. Even high street lenders offer them. The drawback is that the entire loan amount, plus interest, must be paid in one lump sum when the borrower’s payday arrives.

Repayments are typically done by the lender taking out the amount from the borrower’s bank account, using the continuous payment authority. Payday loans typically carry very high interest rates.

Merchant cash advances

This type of short term loan is actually a cash advance but one that still operates like a loan. The lender loans the amount needed by the borrower. The borrower makes the loan payments by allowing the lender to access the borrower’s credit facility. Each time a purchase by a customer of the borrower is made, a certain percentage of the proceeds is taken by the lender until the loan is repaid.

Online or Installment loans

It is also relatively easy to get a short term loan where everything is done online from application to approval. Within minutes from getting the loan approval, the money is wired to the borrower’s bank account.

Lines of credit

A line of credit is much like using a business credit card. A credit limit is set and the business is able to tap into the line of credit as needed. It makes monthly installment payments against whatever amount has been borrowed.

Therefore, monthly payments due vary in accordance with how much of the line of credit has been accessed. One advantage of lines of credit over business credit cards is that the former typically charge a lower Annual Percentage Rate (APR).

There are usually two types of debt, or liabilities, that a company accrues financing and operating. The former is the result of actions undertaken to raise funding to grow the business, while the latter is the byproduct of obligations arising from normal business operations.

Financing debt is normally considered to be long-term debt in that it is has a maturity date longer than 12 months and is usually listed after the current liabilities portion in the total liabilities section of the balance sheet.

Operating debt arises from the primary activities that are required to run a business, such as accounts payable, and is expected to be resolved within 12 months, or within the current operating cycle, of its accrual. This is known as short-term debt and is usually made up of short-term bank loans taken out, or commercial paper issued, by a company,

The value of the short-term debt account is very important when determining a company’s performance. Simply put, the higher the debt to equity ratio, the greater the concern about company liquidity. If the account is larger than the company’s cash and cash equivalents, this suggests that the company may be in poor financial health and does not have enough cash to pay off its impending obligations.

The most common measure of short-term liquidity is the quick ratio which is integral in determining a company’s credit rating that ultimately affects that company’s ability to procure financing.

Quick ratio = (current assets – inventory) / current liabilities

Advantages of Short Term Loans

There are many advantages for the borrower in taking out a loan for only a brief period of time, including the following:

Quick funding time

These loans are considered less risky compared to long term loans because of a shorter maturity date. The borrower’s ability to repay a loan is less likely to change significantly over a short frame of time. Thus, the time it takes for a lender underwriting to process the loan is shorter. Thus, the borrower can obtain the needed funds more quickly.

Shorter time for incurring interest

As short-term loans need to be paid off within about a year, there are lower total interest payments. Compared to long term loans, the amount of interest paid is significantly less.

Easier to acquire

Short term loans are the lifesavers of smaller businesses or individuals who suffer from less than stellar credit scores. The requirements for such loans are generally easier to meet, in part because such loans are usually for relatively small amounts, as compared to the amount of money usually borrowed on a long term basis.

Account receivables refer to the outstanding invoices or money which is yet to be paid by your customers. Until it is paid, such invoices or money is accounted as accounts receivables. Also known as bills receivables. You need cash all the time to keep your business running smoothly and ensuring the accounts receivables are paid on time is essential to manage cash flow efficiently.

And as the term suggests, management of your accounts receivable is called receivable management. Basically, the entire process of defining the credit policy, setting payment terms, sending payment follow ups and timely collection of the due payments can be defined as receivables management. Management of Receivables is also known as:

• Collection Management
• Payment Collection
• Accounts Receivables

Scope of receivable management

When you do sales on credit, you would certainly need to keep track of the due amounts that your parties owe you. All such dues from your parties will be your outstanding receivables. Managing the outstanding receivables can be critical to your business because it not only helps to understand how much your parties owe you, but also helps you to recover the dues on time and use it for your business, as needed.

• Use credit period
• Record and track dues
• Keep a close eye on long-pending bills
• Payment performance of your customer

Importance & benefits of receivable management

Management of receivables refers to planning and controlling of debt owed to the customer on account of credit sales.  In simple words, the successful closure of your order to sales is determined only when you convert your sales into cash.

Another reason, accounts receivables are one of the key sources of cash inflow and given the volume of credit sales, a large amount of money gets tied-up in accounts receivables. This simply implies that so much of money is not available till it is paid. If these are not managed efficiently, it has a direct impact on the working capital of the business and potentially hampers the growth of the business.

Key areas of accounts receivable management

• Once the decision has been taken to grant credit, then suitable credit terms must be set and the receivables that arise must be monitored efficiently if the costs of giving credit are to be kept under control.
• Before a company grants credit to a customer it should ensure, as far as possible, that the customer is worthy of that credit and that bad debts will not result. Checks should continue to be carried out on existing customers as a company would like to have early warning of any problems which may be developing. This is especially true for key customers of the company.
• A key area of the management of accounts receivable is the final collection of cash from customers. Any company must have a rigorous system to ensure that all customers pay in a timely fashion as, without this, the level of receivables and the cost of financing these receivables will inevitably rise, as will the risk and cost of bad debts.

International trade financing is required specially to get funds to carry out international trade operations. Depending on the types and attributes of financing, there are five major methods of transactions in international trade.

An importer of goods can make payments in variety of ways through the banking system. But whatever method is used, the net effect will be to reduce the foreign currency balances of a domestic bank or to increase the rupee balances of an overseas (foreign) bank.

If, for instance, the customer asks his bank for a draft in American bank, so that when the draft is eventually presented for payment at the American bank by the supplier of the goods, the In­dian bank’s account will be debited.

The Indian bank would have charged its customer in rupees for the draft at the appropriate rate of exchange, at the time the draft was issued. A bank can replenish its stocks of foreign currencies by buying from its customers (normally exporters), claims against foreign banks and, if these are insufficient, can buy currencies in the foreign exchange market.

International Trade Payment Methods

Letter of Credit

A Letter of Credit is a letter from a bank that guarantees that the payment due by the buyer to a seller will be made timely and for the given amount. In case the buyer cannot make payment, the bank will cover the entire or remaining portion of the payment.

Prepayment

Prepayment occurs when the payment of a debt or installment payment is done before the due date. A prepayment can include the entire balance or any upcoming part of the entire payment paid in advance of the due date. In prepayment, the borrower is obligated by a contract to pay for the due amount. Examples of prepayment include rent or loan repayments.

Consignment

It is an arrangement to leave the goods in the possession of another party to sell. Typically, the party that sells receives a good percentage of the sale. Consignments are used to sell a variety of products including artwork, clothing, books, etc. Recently, consignment dealers have become quite trendy, such as those offering specialty items, infant clothing, and luxurious fashion items.

Drafts

Sight Draft: It is a kind of bill of exchange, where the exporter owns the title to the transported goods until the importer acknowledges and pays for them. Sight drafts are usually found in case of air shipments and ocean shipments for financing the transactions of goods in case of international trade.

Time Draft: It is a type of foreign check guaranteed by the bank. However, it is not payable in full until the duration of time after it is obtained and accepted. In fact, time drafts are a short-term credit vehicle used for financing goods’ transactions in international trade.

Open Account

Open account is a method of making payments for various trade transactions. In this arrangement, the supplier ships the goods to the buyer. After receiving and checking the concerned shipping documents, the buyer credits the supplier’s account in their own books with the required invoice amount.

The account is then usually settled periodically; say monthly, by sending bank drafts by the buyer, or arranging through wire transfers and air mails in favor of the exporter.

Export Credit and Guarantee:

The Export Credit and Guarantee Corporation Ltd. (ECGC) is a Government of India concern, estab­lished to provide insurance on a commercial basis for exporters. It is not the function of ECGC to provide finance for exporters; it provides only insurance cover for exports.

However, the fact that exports have been insured in this way gives an inducement to financial institutions, particularly the banks, to provide the necessary finance for exports in cases where they would otherwise not be willing to do so.

The Export Credit & Guarantee Dept. of U.K. also performs a similar function. It not only provides guarantees which help to bring forth finance for the exporter, but such guarantees may take the form of financial guarantees to banks and other financial institutions to cover loans direct to overseas buyers, to enable them to buy goods and services from Britain which they might otherwise be unable to finance.

Six types of guarantees have been evolved:

(a) Packing Credit Guarantee

(b) Post Ship­ment Export Credit Guarantee

(c) Export Finance Guarantee

(d) Export Production Finance Guarantee

(e) Export Performances Guarantee

(f) Transfer Guarantee.

Covers issued by ECGC can be divided broadly into the following categories:

(i) Standard policies issued to exports to protect them against the risk of not receiving pay­ments while trading with overseas buyers on credit terms;

(ii) Policies designed to protect Indian firms against the risk of not receiving payments in respect of

(a) Service rendered to foreign parties and

(b) Construction works undertaken abroad

(c) Financial guarantees issued to banks against the risks involved in providing credit to exporters

(d) Special policies.

Trade Finance Methods

The most popular trade financing methods are the following:

Banker’s Acceptance

A banker’s acceptance (BA) is a short-term debt instrument that is issued by a firm that guarantees payment by a commercial bank. BAs are used by firms as a part of the commercial transaction. These instruments are like T-Bills and are often used in case of money market funds.

BAs are also traded at a discount from the actual face value on the secondary market. This is an advantage because the BA is not required to be held until maturity. BAs are regular instruments that are used in international trade.

Accounts Receivable Financing

It is a special type of asset-financing arrangement. In such an arrangement, a company utilizes the receivables the money owed by the customers as a collateral in getting a finance.

In this type of financing, the company gets an amount that is a reduced value of the total receivables owed by customers. The time-frame of the receivables exert a large influence on the amount of financing. For older receivables, the company will get less financing. It is also, sometimes, referred to as “factoring”.

Letters of Credit

As mentioned earlier, Letters of Credit are one of the oldest methods of trade financing.

Working Capital Finance

Working capital finance is a process termed as the capital of a business and is used in its daily trading operations. It is calculated as the current assets minus the current liabilities. For many firms, this is fully made up of trade debtors (bills outstanding) and the trade creditors (the bills the firm needs to pay).

Forfaiting

Forfaiting is the purchase of the amount importers owe the exporter at a discounted value by paying cash. The forfaiter that is the buyer of the receivables then becomes the party the importer is obligated to pay the debt.

Countertrade

It is a form of international trade where goods are exchanged for other goods, in place of hard currency. Countertrade is classified into three major categories; barter, counter-purchase, and offset.

• Barter is the oldest countertrade process. It involves the direct receipt and offer of goods and services having an equivalent value.
• In a counter-purchase, the foreign seller contractually accepts to buy the goods or services obtained from the buyer’s nation for a defined amount.
• In an offset arrangement, the seller assists in marketing the products manufactured in the buying country. It may also allow a portion of the assembly of the exported products for the manufacturers to carry out in the buying country. This is often practiced in the aerospace and defense industries.

International finance, sometimes known as international macroeconomics, is the study of monetary interactions between two or more countries, focusing on areas such as foreign direct investment and currency exchange rates.

International finance (also referred to as international monetary economics or international macroeconomics) is the branch of financial economics broadly concerned with monetary and macroeconomic interrelations between two or more countries. International finance examines the dynamics of the global financial system, international monetary systems, balance of payments, exchange rates, foreign direct investment, and how these topics relate to international trade.

Sometimes referred to as multinational finance, international finance is additionally concerned with matters of international financial management. Investors and multinational corporations must assess and manage international risks such as political risk and foreign exchange risk, including transaction exposure, economic exposure, and translation exposure.

International finance deals with the economic interactions between multiple countries, rather than narrowly focusing on individual markets. International finance research is conducted by large institutions such as the International Finance Corp. (IFC), and the National Bureau of Economic Research (NBER). Furthermore, the U.S. Federal Reserve has a division dedicated to analyzing policies germane to U.S. capital flow, external trade, and the development of global markets.

Scope of International Finance

As there are many prospects that come into the picture and there is the scope it books profits and benefits from each of these prospects accordingly.

• It plays a crucial role in investing in foreign debt securities to have a clear idea about the market.
• It is important while determining the exchange rates of the country. This can be done against the commodity or against the common currency.
• The arbitrage in tax, risk, and price due to market imperfections can be used to book good profits while transacting in international trade.
• The transaction between countries can be significant in assessing the economic conditions of the other country.

International finance analyzes the following specific areas of study:

• International Fisher Effect is an international finance theory that assumes nominal interest rates mirror fluctuations in the spot exchange rate between nations.
• The Mundell-Fleming Model, which studies the interaction between the goods market and the money market, is based on the assumption that price levels of said goods are fixed.
• The optimum currency area theory states that certain geographical regions would maximize economic efficiency if the entire area adopted a single currency.
• Interest rate parity describes an equilibrium state in which investors are indifferent to interest rates attached to bank deposits in two separate countries.
• Purchasing power parity is the measurement of prices in different areas using a specific good or a specific set of goods to compare the absolute purchasing power between different currencies.

The three major components setting international finance apart from its purely domestic counterpart are as follows:

• Market imperfections.
• Foreign exchange and political risks.
• Expanded opportunity sets.

Significance and Importance

• It considers the world as a single market instead of individual markets and carries out the other procedures. For the same reason the firms, corporations doing such research include institutions like International Monetary fund (IMF), International Finance Corp (IFC), the World Bank. Trade between two foreign countries is one the factor for developing the local economy and improve economies of scale.
• In a growing world which is moving towards globalization, its importance is just growing in magnitude. With every day the transaction between two countries for trade is scaling up with the supporting factors.
• Currency fluctuations, arbitrage, interest rate, trade deficit, and other international macroeconomic factors are crucial in prevailing scenarios.

Advantages:

• The scope of growth for companies concentrating on international trade is significantly high compared to companies that don’t.
• There is a range of options in international trade and finance to raise and manage the capital for the business.
• With different currencies involved and more opportunities to manage the capital involved, the financial performance of the company will be improved.
• Revenue from international trade can act as a shield to the company and doesn’t have to worry about domestic demand as they have still demand from overseas.
• The competitiveness of a market improves only when international trade is enabled in such markets. The quality of goods and services will improve without much difference in price due to competition.
• Company has operations in more than one country can act swiftly in case of emergencies and conduct BCP (Business Continuity Protocol)

Disadvantages:

Rivalry Among Countries

There are a few examples when an international business has lead to tension between the nations. Such things mainly take place when one country exports much more to another country, or resort to dumping.

Currency Risk

This is the inherent and one of the biggest risks of doing international business. Since you are doing business in another country, you make sales in that currency only. But, when you repatriate money back to your home country, the fluctuations in the currency may reduce the actual amount. One can, however, overcome it by entering various derivatives contracts.

Another type of currency risk is at the time of the pricing of the product in foreign country. The problem arises when the home currency is strong than the currency of the target market. In this case, a company may have to reduce the selling prices to offer competitive prices in the foreign market.

Foreign Rules and Regulations

Doing business in another country requires a company to follow a lot of rules and regulations. The company also needs to carry a lot of paperwork. Moreover, every country has their own rules when it comes to tax and employment. Adhering to all rules and regulations is not easy. But, a company can overcome this by hiring local tax experts and law agencies.

Destruction of Home Industry

MNCs can result in local companies going out of business. Usually, MNCs are more powerful, when it comes to money. They can resort to aggressive pricing to gain market share. And, this in turn, could drive local companies out of business.

Language Barrier

Different countries have varying languages and culture. This makes it difficult for a foreign company to operate in that country. However, a company can overcome this barrier by hiring local talent, as well as understanding and respecting the culture of another country.

Heavy Opening and Closing Cost

Starting a business requires a lot of money. And, starting a business in a foreign location requires even more money. If the business didn’t do well, then the company would have to shut it down also. In many nations, shutting down a business could be costly, as well as time consuming.

Divestiture (Spinoffs and split-offs)

Divestiture involves selling off a business unit of the company to another company. Companies use divestitures in order to focus on the core units of the company that earn the most revenues. A company can also divest as a way of solving financial issues resulting from non-core areas of the business.

Divestiture can take multiple forms, including as sell-offs, spin-offs, split-offs, split-ups, etc. The main forms of divestiture are spin-offs and split-offs. Spin-offs refer to a business division that is carved out of the parent company and operates as an independent entity. The acquirer allocates shares of the new subsidiary to its stockholders on a pro-rata basis.

On the other hand, a split-off is a subsidiary of the parent company that is split off from the parent company. Shareholders of the latter are allocated shares in the new subsidiary in exchange for shares in the parent company.

Strategic Alliance

It is a voluntary formal agreement between two companies to pool their resources to achieve a common set of objectives while remaining independent entities.

Recapitalization

A recapitalization transaction is a form of corporate reorganization where a company attempts to stabilize its capital structure by exchanging one form of financing for another. For example, the company can exchange the preferred stock or equity in the capital structure and replace it with debt.

A company can implement recapitalization when there is a threat of hostile takeover from its larger competitors or to prevent bankruptcy. Adding more debt to the capital structure would make the company less attractive to investors. During a financial crisis, governments pursue recapitalization in order to keep themselves solvent and protect the financial system from insolvency.

Corporate takeovers

Corporate takeovers occur when a company attempts to assume a controlling interest in another company by acquiring a majority stake in the company. Usually, takeovers involve a larger company acquiring a smaller entity, either through a voluntary or hostile takeover.

A voluntary takeover occurs when the acquirer and target entity mutually agree to the transaction, and the board of directors of the target company willingly approves the transaction. Voluntary corporate takeovers are initiated because the companies find value in each other, and the transaction will bring about operational efficiencies and improvements in revenues.

A hostile takeover is usually a forced acquisition, where an acquirer initiates a takeover attempt without the knowledge of the target company. The acquirer can implement a hostile takeover by purchasing a substantial stake in the target company when the markets open before the management realizes what is happening.

Financial Restructuring:

It is carried out internally with the consent of the various stakeholders by corporates which have accumulated substantial losses.  It is a suitable model for corporate firms accumulating losses over a number of years.  It is achieved by formulating appropriate restructuring scheme involving a number of legal formalities.  It implies significant change in the financial/capital structure of a firm, leading to the change in the payment of fixed financial charges and change in the pattern of ownership and control.

Amalgamation is an arrangement, whereby the assets and liabilities of two or more companies become vested in another company (amalgamated company) without giving proportional ownership to the shareholders of the acquired company. The amalgamating companies all lose their identity and emerge as an amalgamated company, though in certain transaction structures the amalgamated company may or may not be the original companies.

A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt (loans) or assesses the ability of a company to meet its financial obligations. The leverage ratio category is important because companies rely on a mixture of equity and debt to finance their operations, and knowing the amount of debt held by a company is useful in evaluating whether it can pay off its debts as they come due. A leverage ratio is any kind of financial ratio that indicates the level of debt incurred by a business entity against several other accounts in its balance sheet, income statement, or cash flow statement.  These ratios provide an indication of how the company’s assets and business operations are financed (using debt or equity).

There are several different leverage ratios that may be considered by market analysts, investors, or lenders. Some accounts that are considered to have significant comparability to debt are total assets, total equity, operating expenses, and incomes.

Debt-to-Equity Ratio = Total Debt / Total Equity

Debt-to-Assets Ratio = Total Debt / Total Assets

Debt-to-Capital Ratio = Today Debt / (Total Debt + Total Equity)

Debt-to-EBITDA Ratio = Total Debt / Earnings Before Interest Taxes Depreciation & Amortization (EBITDA)

Asset-to-Equity Ratio = Total Assets / Total Equity

A leverage ratio may also be used to measure a company’s mix of operating expenses to get an idea of how changes in output will affect operating income. Fixed and variable costs are the two types of operating costs; depending on the company and the industry, the mix will differ.

A higher financial leverage ratio indicates that a company is using debt to finance its assets and operations often a telltale sign of a business that could be a risky bet for potential investors.

It can mean that earnings will be inconsistent, it could be a while before shareholders can see a meaningful return on their investment, or the business could soon be insolvent.

Creditors also rely on these metrics to determine whether they should extend credit to businesses. If a company’s financial leverage ratio is excessive, it means they’re allocating most of its cash flow to paying off debts and is more prone to defaulting on loans.

A prospective lender may use leverage ratios as part of its analysis of whether to lend funds to a business. However, these ratios do not provide sufficient information for a lending decision. A lender also needs to know if a business is generating sufficient cash flows to pay back debt, which involves a review of both the income statement and statement of cash flows. A lender will also review a company’s budget, to see if projected cash flows can continue to support ongoing debt payments.

Creation:

A business can increase its leverage in a number of ways. The most obvious approach is to take on more debt through a line of credit, where the debt reflects a general increase in the obligations of a firm. A business might also increase its leverage in a more specific manner, such as by taking on a lease obligation when it acquires a specific asset, or when it borrows funds in order to acquire another business. It might also acquire debt in order to conduct a stock buyback, which represents a deliberate increase in leverage, usually to increase the return on investment of the firm’s investors.

Common-base-year financial statements help us see the trends in the different items.

Values in a common-base-year statement as calculated as follows: If base year is 1999, then:

Common-base-year cash in 2000 = Cash in 2000/Cash in 1999

Common-base-year cash in 2001=Cash in 2001/Cash in 1999

Common-base-year inventory in 2000=Inventory in 2000/Inventory in 1999

An activity ratio is a type of financial metric that indicates how efficiently a company is leveraging the assets on its balance sheet, to generate revenues and cash. Commonly referred to as efficiency ratios, activity ratios help analysts gauge how a company handles inventory management, which is key to its operational fluidity and overall fiscal health.

Activity ratios are financial metrics used to gauge how efficient a company’s operations are. The term can include several ratios that can apply to how efficiently a company is employing its capital or assets.

Fixed Assets

Fixed assets are non-current assets and are tangible long-term assets that are non-operating, i.e., not used in the day-to-day activities of a company. Fixed assets usually refer to tangible assets that are expected to provide an economic benefit in the future, such as, property, plant, and equipment (PPE), furniture, machinery, vehicles, buildings, and land.

Fixed Assets Turnover measures how efficiently a company is using its fixed assets.

Fixed Asset Turnover = Revenue / Average Net Fixed Assets

A high ratio indicates that a company may need to invest more in capital expenditures (capex), and a low ratio may indicate that too much capital is tied up in fixed assets.

Working Capital

Working capital, also referred to as operating capital, is the excess of current assets over current liabilities. The level of working capital provides an insight into a company’s ability to meet current liabilities as they come due. Achieving a positive working capital is essential; however working capital should not be too large in order to not tie up capital that can be used elsewhere.

There are three main components of working capital are:

• Receivables
• Inventory
• Payables

The three accounts are useful in determining the cash conversion cycle, an important metric that measures the time in days in which a company can convert its inventory into cash.

Receivables

The accounts receivable turnover measures how efficiently a company is able to manage its credit sales and convert its account receivables into cash.

Receivables Turnover = Revenue / Average Receivables

A high receivables turnover signals that a company is able to convert its receivables into cash very quickly, whereas a low receivables turnover signals that a company is not able to convert its receivables as fast as it should.

The Days of Sales Outstanding (DSO) measures the number of days it takes to convert credit sales into cash.

Days of Sales Outstanding = Number of Days in Period / Receivables Turnover

Inventory

Inventory turnover measures how efficiently a company is able to manage its inventory.

Inventory Turnover = Cost of Goods Sold / Average Inventory

A low inventory turnover ratio is a sign that inventory is moving too slowly and is tying up capital. On the other hand, a company with a high inventory turnover ratio can be moving inventory in a rapid pace; however, if the inventory turnover is too high, it can lead to shortages and lost sales.

Days of Inventory on Hand (DOH) measures the number of days it takes to sell inventory balance.

Days of Inventory on Hand = Number of Days in Period / Inventory Turnover

Payables

Payables turnover measures how quickly a company is paying off its accounts payable to creditors.

Payables Turnover = Cost of Goods Sold / Average Payables

A low payables turnover can indicate either lenient credit terms or an inability for a company to pay its creditors. A high payables turnover can indicate that a company is paying creditors too fast or it is able to take advantage of early payment discounts.

Days of Payables Outstanding (DPO) measures the number of days it takes to pay off creditors.

Days of Payables Outstanding = Number of Days in Period / Payables Turnover

Cash Conversion Cycle

As noted earlier, the cash conversion cycle is an important metric in determining how efficiently a company can convert its inventories into cash. Companies want to minimize their cash conversion cycle so that they receive cash from sales of inventory as quickly as possible. The metric indicates the overall efficiency of a company’s working capital/operating assets’ utilization.

Cash Conversion Cycle = DSO + DIH – DPO

Total Assets

Total assets refer to all the assets that are reported on a company’s balance sheet, both operating and non-operating (current and long-term). Total asset turnover is a measure of how efficiently a company is using its total assets.

Total Assets Turnover = Revenue / Average Total Assets

Types of Activity Ratios

1. Total Assets Turnover Ratio
2. Fixed Assets Turnover Ratio
3. Current Assets Turnover Ratio
4. Working Capital Turnover Ratio

• Stock Turnover ratio
• Debtor Turnover ratio
• Creditors Turnover ratio

1. Total Assets Turnover Ratio

This ratio measures the efficiency of the firm in utilizing its Assets. A high ratio represents efficient utilization of total Assets in generating sales.

Total Assets Turnover Ratio= (Sales or Cost of Goods Sold)/ Total Assets

2. Fixed Assets Turnover Ratio

This ratio measures the efficiency of the firm in utilizing its Fixed Assets. A high ratio represents efficient utilization of Fixed Assets in generating sales.

Fixed Assets Turnover Ratio= (Sales or Cost of Goods Sold)/ Fixed Assets

3. Current Assets Turnover Ratio

This ratio measures the efficiency of the firm in utilizing its Current Assets. A high ratio represents efficient utilization of Current Assets in generating sales.

Current Assets Turnover Ratio: (Sales or Cost of Goods Sold)/ Current Assets

4. Working Capital Turnover Ratio

This ratio measures the efficiency of the firm in utilizing its Working Capital. A high ratio represents efficient utilization of working Capital in generating sales.

Working Capital Turnover Ratio: (Sales or Cost of Goods Sold)/ Working Capital

Stock Turnover ratio

This ratio describes the relationship between the cost of goods sold and inventory held in the business. This ratio indicates how fast inventory/ Stock is consumed/ sold. A high ratio is good for the company. Low ratio indicated that stock is not consumed/ sold or remains in a warehouse for a longer period of time.

Stock Turnover ratio: Cost of Goods Sold/Average Inventory

Average Inventory = (Opening Stock + Closing Stock)/2

Debtor Turnover ratio

This ratio helps the company to know the collection and credit policies of the firm. It measures how efficiently the management is managing its accounts receivable. A high ratio represents better credit policy as compared to a low ratio.

Debtor Turnover ratio: Credit Sales/Average Debtors

Average Debtor = (Opening Debtor + Closing Debtor)/2

Creditors Turnover ratio

This ratio helps the company to know the payment policy that is being offered by the vendors to the company. It also reflects how management is managing its account payable. A high ratio represents that in the ability of management to finance its credit purchase and vice versa.

Creditors Turnover ratio: Credit Purchase/ Average Creditors

Average Creditor = (Opening Creditor + Closing Creditor)/2