Operating Performance Ratios
The next series of ratios we’ll look at are the operating performance ratios. Each of these ratios have differing inputs and measure different segments of a company’s overall operational performance, but the ratios do give users insight into the company’s performance and management during the period being measured.
These ratios look at how well a company turns its assets into revenue as well as how efficiently a company converts its sales into cash. Basically, these ratios look at how efficiently and effectively a company is using its resources to generate sales and increase shareholder value. In general, the better these ratios are, the better it is for shareholders.
In this section, we’ll look at the fixed-asset turnover ratio and the sales/revenue per employee ratio, which look at how well the company uses its fixed assets and employees to generate sales.
Fixed-Asset Turnover
As of March 31, 2010, with amounts expressed in Rs. crores, XYZ had net sales, or revenue, of (income statement) and average fixed assets, or PP&E, of 2,342 (balance sheet - the average of yearend 2009 and 2010 PP&E). By dividing, the equation gives us a fixed-asset turnover rate for FY 2010 of 5.6. Instead of using fixed assets, some asset-turnover ratios would use total assets. We prefer to focus on the former because, as a significant component in the balancesheet, it represents a multiplicity of management decisions on capital expenditures.
Thus, this capital investment, and more importantly, its results, is a better performance indicator than that evidenced in total asset turnover. There is no exact number that determines whether a company is doing a good job of generating revenue from its investment in fixed assets. This makes it important to compare the most recent ratio to both the historical levels of the company along with peer company and/or industry averages. Before putting too much faith into this ratio, it’s important to determine the type of company that you are using the ratio on because a company’s investment in fixed assets is very much linked to the requirements of the industry in which it conducts its business. Fixed assets vary greatly among companies.
For example, an IT company, like XYZ, has less of a fixed-asset base than a heavy manufacturer like BHEL. Obviously, the fixed-asset ratio for XYZ will have less relevance than that for BHEL.
Sales/Revenue per Employee
As of March 31, 2010, with amounts expressed in Rs. crores, XYZ had generated 22,098 in net sales with an average personnel component for the year of approximately 85,000 employees. The sales, or revenue, figure is the numerator (income statement), and the average number of employees for the year is the denominator (annual report) and Sales Per Employee come out to be Rs. 2,500,000.
An ‘Earnings per Employee’ ratio could also be calculated using net income (as opposed to net sales) in the numerator.
Industry and product-line characteristics will influence this indicator of employee productivity. Tracking this figure historically and comparing it to peer-group companies will make this quantitative amount more meaningful in an analytical sense.
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