Turn Baby Turn – Why Inventory Turns Matter

Turn Baby Turn – Why Inventory Turns Matter

Be Sociable, Share! Tweet This is the third part of our series on ratios and what they mean to your business. Inventory turns are the amount of times in a fiscal year that you sell your complete inventory. The ratio is normally calculated by dividing sales by inventory on the year end balance sheet. As an example, if sales are $1,500,000 and inventory is 300,000 on the year end balance sheet, then: In this case the inventory turns five times per year. It can also be calculated by dividing cost of goods sold by average inventory. However, the sales/inventory is the more popular method. If you then divide the number of days in a year by the number of inventory turns, you get the inventory turnover period.  For example, using the 5 inventory turns from above, the inventory turnover period would be 73 days.   The reason this ratio is so important is that the more often the inventory turns the higher the profits. Profit is made each time inventory sells (or at least it better be!), so the quicker it sells the more profits you are bringing in.  A high turnover ratio implies that purchasing is managed well. Alternatively, it may mean that there is not enough cash to maintain normal inventory levels, and so the company is turning away possible sales. The second scenario is most likely when the amount of debt is unusually high and there are few cash reserves.   On the other hand, a low turnover ratio implies  implies that a business may have bought too many goods and their approach to purchasing is unsound. In this case, inventory aging may occur...
Debt to Net Worth – The Pros and Cons of Leverage

Debt to Net Worth – The Pros and Cons of Leverage

Be Sociable, Share! TweetAn old bank customer of mine called me the other day. He was wondering whether he should borrow to finance an impending, but temporary, shortfall in cash flow later in the year. He had sufficient personal cash to inject to get over the hump. I advised him that he was better off in this case using leverage rather than an equity injection. Why? Simply put, leveraging the bank’s balance sheet to fund the temporary shortfall left him with cash for opportunistic inventory purchases, which could increase profits dramatically. Using all available cash removed that option. This is our second article on financial statement ratios and what they mean. The Debt to Net Worth Ratio Debt to Net Worth (also known as Debt to Equity) is the ratio of total liabilities on the balance sheet to owner equity. A company that had $500,000 of liabilities to $100,000 of owner equity would have a Debt to Net Worth ratio of 5/1. For every dollar the owner has in equity, the company owes five dollars to creditors. That would be considered highly leveraged. In some start ups, where the owner is injecting only 10% equity and the bank is financing the rest of the start up capital requirements (nearly always with an SBA guaranty) Debt to Net Worth can be 10/1. Most banks subtract intangible items like goodwill from the owner equity to get a ratio called Debt to Tangible Net Worth. What The Debt to Net Worth Ratio Means It is generally assumed that as companies mature, their Debt to Net Worth will improve over time. A company that...
The Current Ratio – What Does Your Financial Statement Actually Say??

The Current Ratio – What Does Your Financial Statement Actually Say??

Be Sociable, Share! TweetIn this series we will look at the various financial ratios used by bankers, buyers, and investors to evaluate the fiscal health of your company. While there are a great many ratios in common use, we are going to examine the most important and commonly used in financial analysis. The Current Ratio The current ratio is the ratio of current assets to current liabilities on your balance sheet. This is a critical ratio because it demonstrates whether the company is likely to be able to weather short term adversity without significant hardship. The current assets are all assets held by the company that can be converted to cash within one year. Typically this included cash, investments, inventory, and current accounts receivables. Even though some other assets may be sold or liquidated within a year, such as a building, there is no guarantee that liquidation would always happen within 12 months. Those assets are not counted as current assets. Current liabilities are those items that the company has to pay within one year. They are normally accounts payable and current portion of long term debt. It is expected that any fiscally healthy company will have enough current assets, that when converted to cash, are sufficient to pay off all the current liabilities in full. Therefore a company that has current assets of $500,000 and current liabilities of $500,000 would have a current ratio of 1, or 1/1. If, in this example, the current liabilities were $250,000 instead of $500,000, the current ratio would be 500,000/250,000 = 2, or 2/1.   Large, well established companies often have very high current...
Three Tips From a Banker for Getting a Loan for Your Business

Three Tips From a Banker for Getting a Loan for Your Business

Be Sociable, Share! Tweet I’m a former Vice-President and Relationship Manager of a large international bank, and in my lifetime of reviewing loan applications I have found that most business owners are in the dark when it comes to understanding how banks make business lending credit decisions. Yet the answer is surprisingly simple. They want to be 99.5% sure that they will get paid back in full and on time. A bank typically only makes 3.4-3.75% on the money they lend your business. They have to pay depositors, other banks, or the federal government some percentage annually for the use of the money they lend to you. All but the largest banks price their loans by taking the interest they pay to borrow the money they are going to loan to you, and add 3.4-3.75 percentage points onto it. That is how they calculate the interest rate on your loan. Larger banks use a more complicated formula. However, the margin between what the money cost them, and what they charge you, is the gross profit on the loan. And out of that they must pay all the expenses associated with monitoring and servicing the loan. No wonder banks are so skittish when lending to a business. 99.5% of the time they have to be right about whether they will be paid back by their customers in order to make their planned return. And part of that is not only whether they will be paid back in full and on time, but what can they do if they aren’t? Most banks like to see three sources of repayment, and more...
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