FINANCIAL
STATEMENT ANALYSIS 1-37
Number of
turnover times per
year
This means that the firm's inventory is roughly sold out and restocked, or
"turned over," a little more than three times per year. Obsolete,
unnecessary, or excess products held in inventories cause the Asset
Turnover Ratio to fall, which may indicate a need for management action.
Avoid overstating
turnover rate
The analyst should consider two weaknesses of the Inventory Turnover
Ratio. The first concern is that sales are stated at market prices, whereas
inventories are usually carried at cost. In an environment with rapidly
changing prices, the ratio would overstate the inventory turnover rate.
When market prices are volatile, a more accurate calculation may be
made using Cost of Goods Sold in the numerator.
Allow for seasonal
trends
The other weakness is that sales occur over the entire year, whereas
the inventory is valued at a point of time. A business with highly seasonal
trends may calculate the ratio using an average inventory figure.
Average Collection Period
Appraise
collection of
accounts
receivable
The Average Collection Period (ACP) is often used to appraise
A
CCOUNTS
R
ECEIVABLE
. It is computed by dividing average daily sales
by the
A
CCOUNTS
R
ECEIVABLE
. Average daily sales are found by dividing
the total year's
S
ALES
by 360 (the number of days in the year). For
XYZ Corporation, the calculation is:
ACP =
(Accounts Receivable) / (Average Daily Sales)
=
($50.9) / ($287.6/360 days)
=
63.7 days
The Average Collection Period represents the number of days the
company must wait after a sale is made before receiving cash. If XYZ
Corporation gives its customers credit terms of 30 days, this ratio
indicates that the company is inefficient in collecting its receivables.