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Sunday, 16 June 2013

Operating Performance Ratios

The Operating Performance Ratios measure how efficiently and effectively a company is using its resources to generate sales and increase shareholder value. The two most commonly used Operating Performance Ratios are explained below:

I will be using the financial statements of Cisco Systems, Inc. (CSCO) to illustrate how the ratios are computed. Please refer to my post on Important Financial Ratios For Analyzing Businesses for copy of Cisco's Income Statement, Balance Sheet and Cash Flow Statement.

1) Fixed-Asset Turnover

The Fixed-Asset Turnover Ratio measures a company's ability to generate net sales from fixed-asset investments.. This ratio is designed to reflect a company's efficiency in managing its fixed assets investment. A higher fixed-asset turnover ratio shows that the company has been more effective in using the investment in fixed assets to generate revenues.

Formula : Fixed-Asset Turnover Ratio = Net Sales / Property, Plant & Equipment

Benchmark : This ratio is very much industry dependent. Companies in manufacturing industries having heavier fixed-asset base tend to have lower fixed-asset turnover ratio than companies in non-manufacturing industries. Comparing against companies in the same industry is a good way to judge how a company perform in this area.

Note : This ratio is often used as a measure in manufacturing industries, where major purchases are made for PP&E to help increase output. When companies make these large purchases, this ratio is often used to determine whether the new investment in equipment will have a positive effect on revenues.

Calculation : The Fixed Asset Turnover Ratio for Cisco as at 28 Jul 2012 is 46,061 / 3,402 = 13.54.

2) Sales / Revenue per employee

Sales / Revenue per employee is a measure of how efficiently a particular company is utilizing its employees. In general, relatively high revenue per employee is a positive sign that suggests the company is finding ways to generate more sales (revenue) out of each of its workers.

Formula : Sales / Revenue per employee = Revenue / Number of Employees (Average)
Number of employees can be found in the Form 10-K

Benchmark : Labor needs vary from industry to industry, and labor-intensive companies will typically have lower revenue per employee ratios than companies that require less labor. Hence, a comparison of revenue per employee is generally most meaningful among companies within the same industry, and the definition of a "high" or "low" ratio should be made with this in mind.

Note : A company's age can influence its revenue per employee ratio. Young companies may be in the process of escalating their hiring activity to fill key positions, yet their revenues may still be relatively small. Such firms tend to have lower revenue per employee ratios than more established companies that can leverage those same key positions over a larger revenue base.

Calculation : The Sales / Revenue per employee for Cisco as at 28 Jul 2012 is 46,061 / 66,639 = $691,202

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