Ratio Analysis: Delving into Financial Relationships

Financial ratios act as mathematical snapshots, highlighting connections between different items on financial statements. They offer a standardized way to assess performance over time, compare your business to industry benchmarks, and identify areas requiring attention. Let’s focus on two essential ratios relevant to sales analysis:

1. Accounts Receivable (AR) Turnover Ratio:

• Formula: Net Credit Sales / Average Accounts Receivable
• Interpretation: This indicates how many times a year, on average, your company collects its receivables. A higher ratio suggests efficient collections, faster cash flow, and less risk of bad debt.
• ERP Example: Your ERP likely generates sales reports and Accounts Receivable aging reports. Use these to calculate the AR Turnover Ratio, then track it over time for trend analysis.

2. Accounts Payable (AP) Turnover Ratio:

• Formula: Cost of Goods Sold (COGS) / Average Accounts Payable
• Interpretation: Measures how quickly you pay suppliers. A higher ratio might mean you’re taking advantage of early payment discounts. However, a too-high ratio may signal a strained cash position.
• ERP Example: Access your Purchase Order history and Accounts Payable aging reports to compute the AP Turnover Ratio. Compare it with industry averages for benchmarking purposes.

Common Size Statements: Analyzing Relative Performance

Common size statements help visualize financial performance by expressing line items in a financial statement as a percentage of a base figure.

• Vertical Common Size Statements: Each item on a statement is represented as a percentage of a key metric.
  • For Income Statements, line items are commonly expressed as a percentage of Total Revenue.
  • For Balance Sheets, items are often expressed as a percentage of Total Assets.
• Horizontal Common Size Statements: Analyze percentage changes of line items over time (e.g., comparing sales growth across multiple years).

Benefits for Sales Analysis:

• Trend Identification: Easily spot percentage changes in revenue, expenses, AR, etc., over periods within common size statements. This helps identify positive or concerning trends faster.
• Composition Breakdown Vertical analysis on income statements can reveal how much of your revenue is eaten up by various expenses (COGS, marketing, etc.) This aids in finding areas to cut costs and improve profit margins.