Question

Where is the profit in the everyday net profit (income statement) or the efficiency of the assets, explain why?

Answer 1

Profit in the everyday net profit for the efficiency of the assets

Let us analyze how the net profit for efficiency of assets of business is analyzed. We call these methods as efficiency ratios.

Efficiency ratios measure how well the companies are utilizing their assets to generate income. Efficiency ratios often look at the time it takes companies to collect cash from customer or the time it takes companies to convert inventory into cash. Efficiency ratios are used by management to help improve the companies performance and the outside investors and creditors to look at the operational profitability of the company.

When companies are efficient with their resources, they become profitable. Some companies are efficient at turning their assets. Even though they don’t make much profit per sale, they make a ton of sales. Each little sale adds up.

Most common efficiency ratios are:

1. Accounts Receivable Turnover Ratio

It is an efficiency ratio that measures how many times a business can turn its accounts receivable into cash during a period. The accounts receivable turnover ratio measures how many times a business can collect its average accounts receivable during the year.

= Net credit sales / average account receivable

The net credit sales are found on the company’s income statement for the year. Average receivables is calculated by adding the beginning and ending receivables for the year and dividing by two

2. Working Capital Ratio

Measures a firm’s ability to pay off its current liabilities with current assets. This presentation gives investors and creditors more information to analyze about the company

= current asset/ current liability

A ratio more than 1 shows that the company can pay all of its current liabilities and still have current assets left over or simply a positive working capital.

3. Asset Turnover Ratio

The asset turnover ratio is an efficiency ratio that measures a company’s ability to generate sales from its assets by comparing net sales with average total assets

= Net sales/ average total assets

4. Inventory Turnover Ratio

It shows how effectively inventory is managed by comparing cost of goods sold with average inventory for a period. Inventory turnover is a measure of how efficiently a company can control its merchandise. so it is important to have a high inventory turnover ratio.

= Cost of goods sold/ average inventory

Ratios which are presented in income statements are gross margin, profit margin, operating margin, earning per share, price earning ratio, return on stockholders’ equity. In general, the profits relating to the efficiency off assets are not seen in everyday income statement. These are mostly presented for a time period. But the efficiency of assets of a company can be found in sales by converting inventory into cash, credit sales etc. Efficiency ratios are mostly used by the management to improve the company’s performance.