Operating Performance Ratios
Operating performance ratios is an important category of financial ratios analysis. Evaluating the overall company operating performances require analysis of company’s revenue and cost structure, inventory analysis as well as analysis of accounts receivables.
Revenue or sales will show how successfully the organization operates in terms of market share and marketing and sales effectiveness. Next, the company’s cost will give us insight into how efficiently the organization operates to convert the revenue into profit.
The inventory turnover analysis will help us evaluate the efficiency and inventory cycle (how fast the company turns inventory into sales). Finally, the collection analysis will reveal how efficient the company in collecting cash from its revenue is.
Why operating performance ratios are important? Unlike other categories of financial ratios, for example, financial risk ratios used by financial institutions to evaluate the company’s liquidity (ability of the business to pay its payables on time), the operating performance ratios are used to evaluate how successful is an organization in managing the entire business.
Ratios for analysis of operating performances helps you understand the big picture of the business.
What ratios are used for operating performance analysis?
The following are 3 financial ratios you can use for evaluating operating performance of any organization:
1. Return on Assets (ROA)
Return on Assets is very important financial ratio because it measures how productive is the company in terms of using its assets. A successful business will be able to make more use of its assets while unsuccessful businesses are slow on delivering attractive return on assets.
How Return on Assets is calculated:
In its simplest form the ROA is calculated as:
ROA = Net Income / Total Assets
This simple financial ratio will tell you how much net income the company is able to generate by using its assets. The greater the number the better the company is in utilizing its assets. The ROA ratio is an effective measure of management efficiency.
2. Profit Margin
Next ratios in evaluating operational performances is the straightforward and one of the most frequently used ratio by any business: profit margin. The profit margin helps us evaluate the sales and cost structure of the business and the results are used by managers to improve the operating performance by understanding the reason of good or poor performance.
For example if the profit margin is very low, we know that the costs are high in comparison with the revenue. If most of the costs are fixed cost the solution will be to increase the revenue, while in case the fixed costs are low, the solution might be to improve the company operating activities.
Profit margins can be improved in many ways. For example, managers can evaluate their pricing structure (in many cases the pricing strategy can make a big difference) or grow its current revenue or lower the current COGS as well as improve the organizational structure.
The calculation is:
Profit Margin = Net Income / Revenue
3. Revenue per Employee
This simple financial ratio gives you an evaluation of organizational productivity, efficiency and employee productivity. This ratio reveals if a company has a lot of overhead one hand or if the company is productive and has a lean business system.
This ratio varies based on the industry and location. It is always useful to compare companies within the same industry and same country in order to avoid comparing apples and oranges.
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