365 (Days) ÷ 6.82 (Inventory turnover) = 53.5
So Hasbro sells its entire inventory every 53.5 days. Mattel is selling its toys faster.
What do the numbers mean?
Hasbro takes more than 50 days to sell all its inventory, and Mattel sells out every 46.4 days. Mattel turns over its inventory about 8 times a year, while Hasbro turns it over around 7 times per year. To judge how well both com- panies are doing, check the averages for the industry — you can do so online at Bizstats (http://bizstats.com/inventory.htm). Using the stats for Miscellaneous Manufacturing, I find that 8.15 is the average inventory turn- over ratio in the industry. So Mattel is slightly below average at 7.87, and Hasbro, at only 6.82, has some room for improvement.
If the company you’re evaluating has a slower than average inventory turn- over, look for explanations in the management’s discussion and analysis and the notes to the financial statements to find out why the company is perform- ing worse than its competitors. If the rate is higher, look for explanations for that as well; don’t get too excited until you know the reason why. The better numbers may be because of a one-time inventory change.
Investigating Fixed Assets Turnover
Next, you want to test how efficiently a company uses its fixed assets to gen- erate sales, a ratio known as the fixed assets turnover. Fixed assets are assets that a company holds for business use for more than one year and that aren’t likely to be converted to cash any time soon. Fixed assets include items such as buildings, land, manufacturing plants, equipment, and furnishings. Using the fixed assets turnover ratio, you can determine how much per dollar of sales is tied up in buying and maintaining these long-term assets versus how much is tied up in assets that are more quickly used up.
If the economy goes sour and sales drop, reducing variable costs is much easier than reducing costs for maintaining fixed assets. The higher the fixed assets turnover ratio, the more nimble a company can be when responding to economic slowdowns.
Calculating fixed assets turnover
The fixed assets turnover ratio formula is
Net sales ÷ Net fixed assets = Fixed assets turnover ratio
I show you how to calculate this ratio by using the net sales figures from Mattel’s and Hasbro’s income statements and the fixed assets figures from their balance sheets. For both companies, use the line item “Property, plant, and equipment, net.” (If a company doesn’t calculate its fixed assets for you, you have to add several line items together, such as buildings, tools, and equipment.)
Mattel
$5,970,090,000 (Net sales) ÷ $518,616,000 (Net fixed assets) = 11.51 (Fixed assets turnover ratio)
Hasbro
$3,837,557,000 (Net sales) ÷ $187,960,000 (Net fixed assets) = 20.42 (Fixed assets turnover ratio)
What do the numbers mean?
A higher fixed assets turnover ratio usually means that a company has less money tied up in fixed assets for each dollar of sales revenue that it generates. If the ratio is declining, that can mean that the company is over- invested in fixed assets, such as plants and equipment. To improve the ratio, the company may need to close some of its plants and/or sell equipment it no longer needs.
You can tell whether a company’s fixed asset turnover ratio is increasing or decreasing by calculating the ratio for several years and comparing the results. The balance sheet includes two years’ worth of data, so in this exam- ple, you may be able to find the financial statements for 2005 online, or if not, you can request them. Then you’d have the data for 2007 and 2006 on the 2007 balance sheet, and you’d have the data for 2005 and 2004 on the 2005 balance sheet.
Tracking Total Asset Turnover
Finally, you can look at how well a company manages its assets overall by calculating its total asset turnover. Rather than just looking at inventories or fixed assets, the total asset turnover measures how efficiently a company uses all its assets.
Calculating total asset turnover
The formula for calculating total asset turnover is Net sales ÷ Total assets = Total asset turnover
I use information from Mattel’s and Hasbro’s income statements and balance sheets to show you how to calculate total asset turnover. You can find the net sales at the top of the income statement and the total assets at the bottom of the assets section on the balance sheet. Here are the calculations:
Mattel
$5,970,090,000 (Net sales) ÷ $4,805,455,000 (Total assets) = 1.24 (Total asset turnover)
Hasbro
$3,837,557,000 (Net sales) ÷ $3,237,063,000 (Total assets) = 1.18 (Total asset turnover)
What do the numbers mean?
Mattel and Hasbro have similar asset ratios, so their efficiency in using their total assets to generate revenue is about equal. Both companies hold more than half their assets in current assets, which means that they’re relatively liquid and can respond quickly to industry changes.
A higher asset turnover ratio means that a company is likely to have a higher return on its assets, which some investors believe can compensate if the company has a low profit ratio. By compensate, I mean that the higher return on assets could mean increased valuation for the company and, therefore, a higher stock price.
In addition to looking at this ratio, when determining stock value, you need to calculate the profit ratios and return on assets (I show you how to calculate these in Chapter 11). Aside from inventory turnover, another key asset to consider is accounts receivable turnover, which I discuss in Chapter 16.
Examining Cash Inflow and Outflow
In This Chapter
▶ Discovering the ins and outs of accounts receivable
▶ Considering the nuts and bolts of accounts payable
▶ Digging into discount offers
Is the money flowing? That’s the million-dollar, and sometimes multi- million-dollar, question. Measuring how well a company manages its inflow and outflow of cash is crucial to being able to stay in business. Cash is king in business — without it, you can’t pay the bills.
In this chapter, I review the key ratios for gauging cash flow and I show you how to calculate them. In addition, I explore how companies use their internal financial reporting to monitor slow-paying customers, and I discuss whether paying bills early or on time is better and how you can test that issue.
Assessing Accounts Receivable Turnover
Sales are great, but if customers don’t pay on time, the sales aren’t worth much to a business. In fact, someone who doesn’t pay for the products he takes is no better for business than a thief. When you’re assessing a com- pany’s future prospects, one of the best ways to judge how well it’s managing its cash flow is to calculate the accounts receivable turnover ratio.
A balance sheet lists customer credit accounts under the line item “accounts receivable.” Any company that sells its goods on credit to customers must keep track of whom it extends credit to and whether those customers pay their bills.
Financial transactions involving credit card sales aren’t figured into accounts receivable but are handled like cash. The type of credit I’m referring to here is in-store credit, which is when the bill the customer receives comes directly from the store or company where the customer purchased the item.
When a store makes a sale on credit, it enters the purchase on the custom- er’s credit account. At the end of each billing period, the store or company sends the customer a bill for the purchases she made on credit. The cus- tomer usually has between 10 and 30 days from the billing date to pay the bill. When you calculate the accounts receivable turnover ratio, you’re seeing how fast the customers are actually paying those bills.
Calculating accounts receivable turnover
Here’s the three-step formula for testing accounts receivable turnover: