Operational performance ratios measure how different aspects of a company’s finances are performing. The fixed-asset turnover ratio, operating cycle ratio and revenue per employee ratio each provide a different look into how a company is bringing in revenue, if the business is spending its money well and how efficiently it is using its assets and resources. Analyzing these ratios provides deeper insight into the company’s finances than simply studying accounting or other financial records.
Fixed-Asset Turnover Ratio
The fixed-asset turnover ratio is a measure of whether the money a company spends on the equipment and buildings the company owns, often referred to as property, plant and equipment, or PP&E, actually adds value to the company. To find the fixed-asset turnover ratio, divide the company's net revenue by the current value of the fixed assets. A high ratio generally indicates that the company is generating adequate revenue with its assets and that the fixed assets are a wise investment of the company's resources. However, companies that don't require much investment in PP&E, such as consulting firms or IT companies, often have lower fixed-asset turnover ratios than companies that rely more on equipment to make money, such as manufacturers. This means that you must analyze the fixed-assets turnover ratio within the norms of the industry. You also must compare the current fixed-assets turnover ratio to historical fixed-asset turnover ratio figures to determine if the ratio is increasing or decreasing. A declining ratio may indicate that the company has too much money tied up in its equipment or property. An increasing ratio often indicates that the company is making better use of its property and equipment or has upgraded effectively.
The operating cycle ratio shows if a company is managing its accounts payable, accounts receivable and inventory efficiently. The operating cycle ratio involves three aspects of the company's finances; the days inventory outstanding, the days sales outstanding and the days payable outstanding. These aspects all are calculated the same way. Divide the cost of processing the accounts payable, accounts receivable or inventory by 365, the number of days in a year, to get the daily cost. Add the beginning and ending balances of the accounts payable, accounts receivable or inventory account and divide the answer by two to get the average amount for each account. Divide the average amount by the cost per day to find the days inventory outstanding, days sales outstanding or days payable outstanding. Calculate the operating cycle ratio by adding the days inventory outstanding and the days sales outstanding, then subtracting the days payable outstanding. The resulting figure is expressed as a number of days. A shorter operating cycle means that a company collects money from customers efficiently, has good payment terms with businesses and other entities to which it owes money and is moving inventory at a pace that keeps up with average production ability and customer demand. A longer operating cycle indicates that the business has too much money tied up in unsold inventory, uncollected payments and unpaid operating expenses. To perform an accurate analysis, the operating cycle ratio should be compared against industry standards, competitor operating cycle data and the company's own historical operating cycle information.
Revenue Per Employee Ratio
The revenue per employee ratio indicates how much revenue each employee is producing for the company. To find the revenue per employee ratio, divide the annual revenue the company earns by the number of employees it has. This ratio is expressed as a dollar amount. A high revenue per employee ratio means that employees are generating adequate sales or revenue for the company, while a low ratio is often a sign of low productivity. This is especially true for labor-heavy industries, such as retail and manufacturing. However, businesses that do not rely as much on employee productivity, such as technology fields, may have lower revenue per employee ratios, even if the company’s employees are producing adequate revenue. For this reason, you must compare the revenue per employee ratio to other companies in the same industry to get an accurate idea of what is normal.
Improving Operational Performance Ratios
To increase the fixed-asset turnover ratio, upgrade or replace outdated equipment and property. The company also may be able to refinance any loans on the assets to liquidate the capital. Reduce expenses that cause a low fixed-asset turnover ratio, such as costly repairs, by providing regular maintenance to property. To improve a long operating cycle ratio, increase collection efforts on accounts receivable to ensure timely payment from customers. This may include more frequent billing or increased collection calls and correspondence. You can decrease unused inventory by putting on sales or selling overstock products to resellers. Negotiate for more favorable payment terms with creditors to give the company more time to pay bills without incurring late payment penalties or additional interest. A low revenue per employee ratio requires the company to increase employee output. Measures such as increased pay, rewards and recognition, retraining or continuing education, upgrading equipment and restructuring management all can make a difference in employee productivity. If these measures are unsuccessful, the company may simply have too many employees and not enough work. In this case, the company may have to lay off workers.