All about Profit and Loss Statement Ratios

Every trader or investor aims to make fruitful trades or investments. However, the road to success is long and it takes systematic preparation. While what we have learnt so far will give you a broad idea of what to look for when you analyse a company's earnings, it's important that you also know of some financial tools that will help make your task easier.

In this chapter and a few upcoming chapters, we learn all about financial ratios. We will cover what are financial ratios in a stock market and various types of financial ratios that you can use to make sense of a company's financial performance.  

Let/s begin this journey with financial ratios from the Profit and Loss Statements and their practical application. These ratios can be classified as:

• Asset efficiency ratio
• Collection efficiency ratio

Let’s take a detailed look:

Asset efficiency ratio

Asset efficiency ratio measures how efficiently assets are put to use to generate revenue. They are:

Total asset turnover:

This compares sales generated out of the total assets.

Formula: Sales/Total assets

Net fixed asset turnover:

This ratio measures the sales to net fixed assets.

Formula: Sales/Net fixed assets

A brief analysis:

A study of the above  tables reveals a declining trend in both ratios since March 2019. This may be due to the additional assets that were created. In the coming years, efficiency may improve as sales rise. This ratio is perfectly suited for companies in the manufacturing industry.

Collection efficiency ratios

These are a set of ratios that measure how quickly, or efficiently current assets, such as debtors and inventories are into cash. It also measures how quickly creditors are paid off.

Receivables turnover

It measures the number of times sundry debtors are converted into cash, i.e., the frequency of collection.

Formula: Net sales/Average receivables

Along with this, we can calculate the receivable days, which tells us how many days receivables stay as receivables in the books on average before a customer pays.

Formula: No of days in a year (365 days)/Receivables days

A brief analysis:

The higher the receivable collection turnover, the higher the collection frequency, and this is evident from the above table. The receivables turnover ratio has come down from 38.81 to 29.56. The frequency has reduced. The receivables days have also increased from 9.41 days to 12.35 days. This means the collection period has increased, showing some lax in the collection.

Inventory turnover:

This refers to how many times inventory is replenished during the year. The more, the better, as it shows the demand for the product is high.

Formula: Cost of goods sold/Inventory

The inventory days are the time taken for the inventory to get replenished.

Formula: No. of days in a year (365 days)/Inventory turnover

A brief analysis:

The number of times, or the frequency, of replenishing the inventory is stable in the range of around 6 times. The inventory days, i.e., the time taken to replenish the inventory is also more or less stable.

Payables turnover:

This ratio measures how frequently the sundry creditors are paid off. Credit purchases from suppliers are made regularly for manufacturing or trading activities. This ratio measures how fast a company sells its goods and receives cash to pay off its creditors.

Formula: Cost of goods sold/Total payables

We will use the cost of goods sold as many elements are bought on credit. Also, on the denominator, we will add trade payables and other current liabilities.
Payable days are the number of days within which creditors are paid off.

Formula: No. of days in a year/Payables turnover

A brief analysis:

In the above table, we can see that the payables turnover frequency has reduced from 6.02 in March 2019 to 3.55 times in March 2021. The number of days taken to pay off creditors has also increased substantially from around 61 to 103 days. While it is good for the company, it will impact its reputation. Many times, supplies are bought if the prices are expected to rise in future. This could also be one of the reasons for the increased number of days.

Working capital cycle:

This is the total of the receivable days, inventory days-payable days.

 
A brief analysis:

In March 2021, the payable days increased to 102.74, which could be a temporary effect. The receivable and inventory days are in a stable range.

Points to remember:

• P&L Statements can throw light on various aspects of a company’s health
• You must keep these efficiency ratios handy while studying the statement
• Calculations will give you a clear idea about whether the company is worth investing in