Your Queries: Know what investment utilisation ratios say about a firm

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June 08, 2021 2:00 AM

Fixed Assets Turnover is computed by dividing the revenue of a firm by its tangible fixed assets.

For all the five ratios, higher the output, better is the utilisation of capital employed and capital invested. One could do both intra- and inter-firm comparative analysis to get more insights.

One of the key traits of a financially sound firm is its efficiency in utilising its investments/capital. Investment utilisation ratios such as asset turnover, working capital turn, fixed asset turn and capital utilisation ratios such as invested capital turn and equity turn enable the investors in getting clear insights on the performance of their investment potentials.

Hypothetical illustration
Let us assume the following figures (amount in Rs crore) for Abhan Harsh Ltd (AH) for its latest financial year: Total assets 24,000; current assets 8,000; property plant and equipment (PPE) 10,000; current liabilities 3,000; sales revenue 20,000; shareholders’ funds 12,000.

Asset Turnover
It is computed by dividing revenue of a firm by its total assets. For AH, it is 0.83 times (revenue of Rs 20,000 crore / total assets of Rs 24,000 crore). This reflects AH is generating revenue of Rs 83 for every Rs 100 invested in its assets. If its previous period asset turn is 0.78, then the firm has improved its asset utilisation in the current year.

Working Capital Turnover
It is calculated by dividing the revenue of a firm by its working capital. For AH, it is four times (revenue of Rs 20,000 crore / working capital of Rs 5,000 crore). Working capital is the excess of current assets over current liabilities. This reveals AH is generating revenue of Rs 4 for every Rs 1 invested in its working capital. If its previous period WC turn is 5, then the firm has gone down in its working capital utilisation in the current year.

Fixed Asset Turnover
It is computed by dividing the revenue of a firm by its tangible fixed assets. For AH, it is 2 times (revenue of Rs 20,000 crore/PPE of Rs 10,000 crore). This indicates that AH is generating revenue of Rs 2 for every Rs 1 invested in its tangible fixed assets. If its previous period FA turn is 1.75, then the firm has improved its FA utilisation in the current year.

These three ratios look at the investment utilisation by comparing the sales revenue of a firm with its asset variants such as net current assets, tangible fixed assets, and total assets. However, investors would like to know how a firm is utilising its capital.

Invested Capital Turnover
It is calculated by dividing the revenue of a firm by its invested capital. For AH, it is 0.95 times (revenue of Rs 20,000 crore / invested capital of Rs 21,000 crore). This indicates that AH is generating revenue of Rs 95 for every Rs 100 of its invested capital. If its previous period IC turn is 0.75, then the firm has improved its IC utilisation in the current year.

Equity Turnover
It is computed by dividing the revenue of a firm by its shareholders funds. For AH, it is 1.67 times (sales revenue of Rs 20,000 crore / shareholders’ funds of Rs 12,000 crore). This reflects that AH is generating sales revenue of Rs 167 for every Rs 100 of its shareholders’ funds. If its previous period equity turn is 1.50, then the firm has improved its equity utilisation in the current year.

For all the five ratios, higher the output, better is the utilisation of capital employed and capital invested. One could do both intra- and inter-firm comparative analysis to get more insights.

The writer is associate professor of Finance at XLRI – Xavier School of Management, Jamshedpur

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